Asia 2050: Realizing the Asian Century

ASIA 2050 Realizing the Asian Century

ASIA I 2050 Realizing the Asian Century r

© 2011 Asian Development Bank All rights reserved. Published 2011. Printed in Singapore. Asia 2050: Realizing the Asian Century The views expressed in this publication are those of the authors and do not necessarily reflect the views and policies of the Asian Development Bank (ADB) or its Board of Governors or the governments they represent. ADB does not guarantee the accuracy of the data included in this publication and accepts no responsibility for any consequence of their use. By making any designation of or reference to a particular territory or geographic area, or by using the term “country” in this document, ADB does not intend to make any judgments as to the legal or other status of any territory or area. ADB encourages printing or copying information exclusively for personal and noncommercial use with proper acknowledgment of ADB. Users are restricted from reselling, redistributing, or creating derivative works for commercial purposes without the express, written consent of ADB. Note: In this publication, “$” refers to US dollars. Asian Development Bank 6 ADB Avenue, Mandaluyong City 1550 Metro Manila, Philippines Tel +63 2 632 4444 Fax +63 2 636 2444 www.adb.org iv

Contents

Page number

vii xi xiii xv 1 11

List of figures, tables and boxes List of abbreviations Foreword Preface Executive Summary and Conclusions Background and Introduction

11

What is “Asia”?

12

Is the “Asian Century” preordained?

15

Asia in the Global Economy during 1750-2010: Setting the Scene

15

Decline and re-emergence: 1750-1990

15

Reaping of the globalization dividend: 1990-2010

19

Asia in the Global Economy 2011-2050: Main Drivers of the Asian Century

19

Classic drivers of growth

23

The new drivers of transformation

27

From growth to social well-being

29

Asia in the Global Economy in 2050: The Asian Century

29

Basic assumptions

29

Three country groups

30

The Asian Century

31

Asia’s growing global footprint

33

Realizing the Asian Century: Mega Challenges and Risks

33

Inequities within countries

33

Middle income trap

34

Competition for finite natural resources

35

Disparities across countries and subregions

36

Global warming and climate change

36

Governance and institutional capacity

36

Mega risks

39

Realizing the Asian Century: A Strategic Framework

39

Three dimensions

40

National action v

CONTENTS

44

Regional cooperation

45

Global agenda

47

Realizing the Asian Century: Inclusion and Equity

47

What is inclusive growth?

47

Why focus on inclusion and equity?

48

What is the status in Asia?

50

What is needed?

55

Realizing the Asian Century: Financial Transformation

55

Asia’s financial rise

55

Conventional wisdom in finance

56

Asia in the international financial architecture

57

Taming finance to serve the real sector

58

Transformational changes to serve the real sector

61

Regional cooperation and Asia’s global financial leadership

63

Realizing the Asian Century: A New Approach to Urbanization

63

Asia’s urbanization avalanche

63

Cities of the future

66

Major risks to be managed

68

Priority agenda

71

Realizing the Asian Century: Reducing Energy Intensity and Ensuring Security

71

Rising energy consumption

71

Energy import dependency

73

Priorities for domestic action

75

Priorities for regional cooperation

77

Realizing the Asian Century: Action on Climate Change in Asia’s Self Interest

77

Business as usual

78

Developed country action alone

79

Complementary action by developing economies

81

Accelerating the transition to low carbon economies

82

Global burden sharing

83

Realizing the Asian Century: Entrepreneurship, Innovation and Technological

83

Why focus on entrepreneurship and innovation?

84

Entrepreneurship and innovation in Asia

85

Major lessons

Development

vi

Key elements of the entrepreneurship and innovation eco-system

91

Priorities

93

Realizing the Asian Century: Transforming Governance and Institutions

93

Analytic framework

93

The governance challenge in Asia

96

Drivers for change in governance and institutions

100

Key actors of institutional change

100

Principles and priorities

103

Realizing the Asian Century: Regional Cooperation and Integration

103

Regional cooperation matters for Asia’s future

103

Cooperation instead of conflict

105

Progress to date with regional economic integration

106

Drivers of economic integration

107

Prospects for further economic integration

110

Countours of future cooperation and integration

110

Priority areas to facilitate regional cooperation

111

Institutions for regional cooperation

111

Prospects and institutional options

115 115

Realizing the Asian Century: Asia’s Role in the World A rising stake in the global commons

115

Global trading system

115

Global financial system

116

Stance on climate change

116

Stake in global peace and prosperity

116

Relations with other parts of world

117

Impact of national and regional policies on others

117

Global governance

117

Managing Asia’s rise

119

CONTENTS

86

The Asian Century vs. the Middle Income Trap: Opportunity Cost

119

Cost of missing the Asian Century

120

The intangibles

120

The human dimension

121

Annex 1: Demographic Changes in Asia’s Regions by 2050

125

Annex 2: Model for Developing Global Growth Scenarios

vii

List of Figures, Tables and Boxes

Figures

Chapter 10

Executive Summary 1

Strategic framework

2

Asian Century vs. Middle Income Trap

1

Asia will lead world energy demand

2

PRC and India will experience a significant increase in energy-related

Chapter 2

carbon emissions

1

Asia’s share of global GDP has bottomed

2

World GDP growth rate is steadily

Chapter 11 1

increasing 3

Developing Asia GDP growth, 1990-2015

4

Trade is increasing in relevance

Chapter 3 1

incentives to address climate change 2

mitigate damage from climate change

Asian total factor productivity (1990-2050)

1

Working age population (20-64) will (1990-2050)

2 3

Asia should move decisively on the

convergence level Chapter 13 1&2

global commons because that is in its self-interest 5

3&4 5&6

Strategic framework Asia’s economies rank low with regard to

Chapter 14 1

From conflict to cooperation

2

Asia has experienced an increase in share

gender parity 2

Large difference exist between subregions with regards to vocational education and training (VET)

Chapter 8 1

of intra-regional trade Chapter 16 1

Asia’s global share of bonds, equities,

Chapter 9

Asian Century vs. Middle Income Trap

Annex 1 A1

and bank assets will rise 1

Governance indicators by subregion (weighted by GDP)

Chapter 7 1

Asia-7 has still underperformed the rest of the world in governance

Chapter 6 1

Asia-7 has outperformed the rest of Asia in governance

Mobile phone subscriptions still have room for growth in PRC and India

Asian countries’ rankings in ease of doing business vary by region and income/

world’s added capital stock between 4

Much of Asia lags in secondary and tertiary enrollment

Asia will account for 70 percent of the 2030 and 2050

Total factor productivity levels and growth rate, 1985-2007

begin to decline in all Asian subregions 3

Action by Asian countries can significantly

Chapter 12 is converging with best practice

2

Asia has both the ability and the

Population changes in Asia’s subregions, 2010 versus 2050

Tables Executive Summary

Northeast Asia will be the most urbanized

1

region of Asia 2

Urban Gini coefficient (by country)

3

Urban Gini coefficients over time

Asia’s urban population will nearly double by 2050

Chapter 3 1

The West currently accounts for the bulk of global middle class spending ix

2

The Asian middle class will grow sharply

A3

over the next 40 years 3

Damages as % of GDP in 2100 could be

inflection years A4

FIGURES, TABLES AND BOXES

as High as 8.6% in Asia 4

2050 Boxes

picking up in Asia

Executive Summary 1

The Asian Century: Asia will account for more than half of global output in 2050

Asian countries

Chapter 4 1

Asia’s urban population will nearly double

Chapter 5

by 2050

1

Projection of energy demand and supply

2

in Asia Asian cities feature prominently in the list level rises Chapter 13 Analytic framework for governance and

2

Working age population as a % of total population will begin to decline for all Northeast Asia will be the most urbanized subregion of Asia

4

Pressures for governance and institutional

1

1 1

Republic of Korea’s transformation into a

2

From catch-up to frontier innovation

center of science and technology Chapter 14 1

Population changes in Asia, 2010-2050 Projected growth of Asia’s elderly population (number of people, age 65 and above, in millions)

x

Central Asia’s triple integration opportunity

4

A1

Regional cooperation and integration in South Asia

3

Income Trap

A2

Moving towards cooperation without conflict: learning the lessons of history

Economic 2050 outcomes under two

Annex 1

Progress in green technology

Chapter 12

2 scenarios—Asian Century and Middle

Vision for a successful Asian city of 2050

Chapter 11

transformation—domestic Chapter 16

Two faces of Asia

Chapter 9

subregions 3

Asia and the Millennium Development Goals

2 1

institutions

Risks of conflict in Asia

Chapter 7 1

of cities most exposed to half metre sea-

1

The Middle Income Trap: unable to compete

Chapter 11 1

The engines of the Asian century are the Asia-7 economies

Chapter 10 1

The Middle Income Trap: unable to compete

Inequality is increasing in a number of

Chapter 9 1

The Asia-7—engines of Asia’s re-emergence

2

Chapter 7 1

Ageing versus economic growth in Asia,

Internet usage is skyrocketing globally,

Chapter 4 1

Asia’s differential-speed demographic

ADB proposals for new regional institutions

List of Abbreviations

ADB

Asian Development Bank

IEO

Independent Evaluation Office

AfPak

Afghanistan-Pakistan

IOSCO

International Organization of Securities

AMF

Asian Monetary Fund

ASEAN

Association of Southeast Asian Nations

MDG

ASEM

Asia-Europe Meeting

MER

market exchange rate

ASX

Australian Stock Exchange

Mbd

million barrels per day

BAU

business as usual

Mtoe

million tonnes of oil equivalent

Bcm

billion cubic meters

NIE

newly industrialized economies

BCG

Boston Consulting Group

NIC

newly industrializing countries

BIS

Bank for International Settlements

OECD

Organization for Economic Cooperation and

BIMSTEC

Bay of Bengal Initiative for Multisectoral

CAREC

Commissions Millennium Development Goals

Development

Technical and Economic Cooperation

ODA

Overseas Development Assistance

Central Asia Regional Economic

OTC

over the counter

Cooperation

PISA

Program for International Student Assessment

CO2

carbon dioxide

CCS

carbon capture and storage

PPP

purchasing power parity

DAC

Development Assistance Committee

PPP

public private partnerships

EFSF

European Financial Stability Fund

PRC

People’s Republic of China

EU

European Union

R&D

research and development

EMEAP

Executive Meeting of the East Asia and

SAARC

South Asian Association of Regional Cooperation

Pacific Central Banks FTA

Free trade area

GDP

gross domestic product

SASEC

South Asia Subregional Economic Cooperation

GE

General Electric

SAGQ

GERD

gross expenditure on research and

SGX

South Asia Growth Quadrangle Singapore Exchange

development

TFP

total factor productivity

GFC

Global Financial Crisis

TWh

terawatt hours

GMS

Greater Mekong Sub-region Program

WTO

World Trade Organization

HNWI

high net worth individual

IMF

International Monetary Fund

ICP

International Comparison Program (of the

ICT

information and communications technology

IEA

International Energy Agency

World Bank)

xi

Foreword

The rapid rise of Asia over the past 4-5 decades has been one of the most successful stories of economic development in recent times. Today, as Asia leads the world out of recession, the global economy’s center of gravity is once again shifting toward the region. The transformation underway has the potential to generate per capita income levels in Asia similar to those found in Europe today. By the middle of this century, Asia could account for half of global output, trade, and investment, while also enjoying widespread affluence. While the realization of this promising outcome—referred to as the “Asian Century”—is plausible, Asia’s rise is by no means pre-ordained. Given Asia’s diversity and complexity, this rapid rise offers both important opportunities and significant challenges. In its march towards prosperity and a region free of poverty, Asia will need to sustain high growth rates, address widening inequities, and mitigate environmental degradation in the race for resources. In addition, Asian economies must avoid the middle income trap in order to realize the Asian Century. To meet these challenges, Asian leaders need to devise bold and innovative national policies, while pursuing avenues for regional and global cooperation. Policies that were effective in the past when Asia was largely a low-income, capital-scarce region are less likely to be effective today or in the future. It is in this context that the Asian Development Bank (ADB) commissioned the Asia 2050 study to develop plausible scenarios of where the region could be in 40 years; identify the drivers of change and the policy choices that the region must make; and outline the corresponding national, regional, and global agendas for the region. To develop a long-term vision for Asia, ADB requested a group of experts to set out a framework to analyze multi-dimensional and multi-generational issues. Most significantly, from the outset, we encouraged extensive consultations to share the findings and receive feedback from policymakers, think tanks, civil society, and academia. Together with the experts, ADB senior staff and my Management Team, I participated in many of these. I am thankful for these frank and intensive discussions that enriched the study. This publication, Asia 2050: Realizing the Asian Century, is an overview specifically prepared for the Governors’ Seminar at the 44th Annual General Meeting of the ADB to be held in Hanoi on 5–6 May 2011. With inputs from the Governors’ Seminar, this publication will be expanded into a comprehensive book in August 2011. Since the Asia 2050 study was commissioned to foster a debate on development challenges in Asia, ADB will continue the consultative process and my management team and I will join as many of the discussions as possible. The changes in policies and strategies outlined in this publication that are needed to address the challenges that Asia faces will likely have long gestation periods. We must therefore act now. The failure to meet these challenges would deprive Asians of potential affluence and greater well-being for a generation or more. I recommend this overview to all those interested in the long-term economic and social development of Asia. And, as always, we would greatly appreciate your feedback.

Haruhiko Kuroda President Asian Development Bank xiii

xiv

Preface

economies—such as PRC, India, Indonesia,

This study is aimed at senior policy makers, top business leaders and key opinion makers within Asia

Thailand and Viet Nam—will have to overcome

to help forge a consensus on a vision of and strategy

in the next 40 years and that the newly indus-

for Asia’s potentially historic rise among the global

trialized countries did not have to face during

community of nations between now and 2050.

the past 40 (slower growing, less confident

The study offers a long-term perspective of the

and more inward looking North America and

Asia region as a whole as opposed to the more com-

Europe; likely intensive competition for finite

mon approach that delivers a short- to medium-term

natural resources; adverse impact of climate

perspective of selected countries, subregions or

change; need to go beyond the current global best practice, and so on).

issues. The study attempts to add new value and insights particularly in the following five respects: t


t


First, it challenges the growing perception

for Asia as a whole to continue its rapid devel-

that Asia’s rapid rise in the global economy is

opment (e.g., need for a new pattern of growth;

inevitable, as if the region is on “autopilot.” The

greater focus on inclusive growth and urbanization) while avoiding the Middle Income Trap.

report highlights significant risks that could lead to economic, social and even political instability

t


Fourth, it examines the prospects and options

and, in turn, derail economic development and

for Asian regional cooperation and integra-

growth. This extensive list of risks, includes,

tion. It argues for an unhindered flow of trade

but is not limited to: continuing, or increas-

and investments throughout Asia based on a

ing, social disparities and inequities; People’s

bottom-up market-based approach, as well as

Republic of China (PRC), India and many oth-

greater collaboration between countries per-

ers falling into the Middle Income Trap (Chapter

mitting them to prosper together in a peaceful and harmonious manner.

5, Box 1); and steady decline in the quality and credibility of institutions (political, economic,

t


Third, it outlines the prerequisites and strategy

t


Fifth, it highlights the opportunities and obliga-

police, judiciary). Given the economic history

tions that would arise out of Asia’s rapidly

of other once successful regions and countries

expanding global presence. Managing this

(notably Japan and Brazil before and after the

unprecedented rise in a peaceful and harmoni-

1980s), it cautions policy makers and business

ous manner will require patience and humility

leaders against becoming complacent.

on the part of all major Asian players.

Second, the study highlights new challenges that the current middle income

xv

Executive Summary and Conclusions

Asia is in the midst of a truly historic transformation. If

t


Rising disparities across countries and subre-

it continues to grow on its recent trajectory, it could,

gions could destabilize the region and halt its

by 2050, account for more than half of global Gross

growth momentum.

Domestic Product (GDP), trade and investment, and

t


Global warming and climate change (includ-

enjoy widespread affluence. Its per capita income

ing increased natural disasters), as well as

could rise sixfold to reach the global average and be

associated water shortages, could threaten

similar to European levels today (though Europe and

agricultural production, coastal populations and

North America will remain much richer in per capita

numerous major urban areas.

terms). It thus holds the promise of making some 3

t


In addition, almost all countries face the over-

billion additional Asians, hitherto commonly associ-

arching challenge of governance and institu-

ated with poverty and deprivation, affluent by today’s

tional capacity.

standards. By nearly doubling its share of global GDP (at market exchange rates) from 27 percent in 2010 to

These challenges are not mutually exclusive. They can

51 percent by 2050, Asia would regain the dominant

impact one another and multiply existing tensions,

global economic position it held some 250 year ago,

unrest, and conflicts, or even create new pressure

before the Industrial Revolution. Some have called this

points within and across Asia that threaten its growth,

possibility the “Asian Century”.

stability, and security.

While this promising outcome, premised on the major

Based on Asia’s record over the past twenty-five

economies sustaining the present growth trajectory,

years, it is possible to categorize Asian economies

is plausible, it does not imply that the path ahead is

into three groups. Seven1 have grown rapidly since

just doing more of the same. Indeed, just maintaining

the 1950s, avoiding the Middle Income Trap and

the present growth momentum will require a different

becoming high-income developed economies in one

pattern of growth and urgent tackling of a broad array

generation. Another 11 economies2, including the two

of politically difficult issues over a long and sustained

giant economies of the People’s Republic of China

period. Asia’s rise is by no means preordained.

(PRC) and India, have demonstrated consistently high growth since 1990 and already reached middle

Indeed, this outcome is fraught with multiple risks and

income status, but they now face the greatest risk of

challenges, particularly:

falling into the Middle Income Trap (Box 1). Several

t


t


Large and, in some cases, increasing inequities

of these economies, or the larger ones, could eas-

within countries could undermine social cohe-

ily derail the enticing prospect of the Asian Century.

sion and political stability.

Finally, 31 economies—including a large number of

Individual countries risk falling into the Middle

smaller countries—have achieved only modest or low

Income Trap due to a host of domestic eco-

long-term growth.3 Their success in joining the ranks

nomic, social and political challenges. t


Intense competition for finite natural resources (such as energy, water and fertile land) unleashed by this growth, as the newly affluent Asians aspire to higher standards of living.

1 Brunei Darussalam; Hong Kong, China; Japan; Republic of Korea; Macau, China; Singapore; and Taipei,China; these economies have per capita income over $12,196. 2 Armenia; Azerbaijan; Cambodia; PRC; Georgia; India; Indonesia; Kazakhstan; Malaysia; Thailand; and Viet Nam. 3 In this study, Asia is defined to comprise three Asian subregions; East Asia and the Pacific (including Democratic People’s Republic of Korea); South Asia;

1

“

The Asian Century scenario extends Asia’s

past success into the future, putting it on the cusp of a truly historic transformation

Box 1

The Asia-7—engines of Asia’s re-emergence

EXECUTIVE SUMMARY AND CONCLUSIONS

Asia’s rise will be led by PRC, India, Indonesia, Japan, Republic of Korea, Malaysia, and Thailand. In 2010 these seven economies had a combined total population of 3.1 billion

Makings of the Asian Century The Asian Century scenario essentially extends Asia’s past success into the future, putting it on the cusp of a truly historic transformation. In this scenario, Asia’s GDP (market exchange rates) would increase from

(78 percent of Asia) and a GDP of $14.2 trillion

$16 trillion in 2010 to $148 trillion in 2050, or half of

(87 percent of Asia). By 2050 their share in

global GDP, similar to its share of the global popula-

population is expected to fall to 73 percent

tion. With a per capita GDP of $38,600 (PPP), Asia in

of Asia, while the share of GDP rises to 90

2050 would have incomes similar to Europe today. It

percent. These seven economies alone will

would have no poor countries (with average per capita

account for 45 percent of global GDP. Their

GDP of less than $1,000), compared with seven

average per capita income of $45,800 (PPP)

today. All this assumes that Asian economies can

would be 25 percent higher than the global

maintain their momentum for another 40 years and

average of $36,600.

adapt to shifting global economic and technological environment by continually recreating their comparative advantage.

of the fast-growing group would significantly facilitate the spread of affluence to all Asians.

Actions at three levels

This report postulates two scenarios of Asia’s future

But in its march towards the Asian Century, the region

growth trajectory: the Asian Century and Middle

must tackle daunting policy, institutional and gover-

Income Trap scenarios (paragraphs 35 and 36). But

nance challenges along the way. Given widely varying

these scenarios are by no means exhaustive—instead

country conditions, the precise actions and their tim-

they are only two possible trajectories of how the fu-

ing must vary. Still, it is possible to draw the contours

ture may unfold. They have a single objective: to draw

of the major changes necessary for the region along

attention to the longer-term implications of the broad

three dimensions: (i) national strategic and policy

trends and to ask what-if questions.

actions; (ii) collective regional actions to bridge the national and global agendas; and (iii) Asia’s interactions with the global community (Figure 1). The ability of the diverse countries in Asia to realize the promise of the Asian Century will be determined by their success, individually and collectively, in addressing these

and Central Asia (including Iran). The 49 economies covered are: Afghanistan; Armenia; Azerbaijan; Bangladesh; Bhutan; Brunei Darussalam; Cambodia; People’s Republic of China (PRC); Cook Islands; Democratic People’s Republic of Korea; Fiji; Georgia; Hong Kong, China; India; Indonesia; Iran; Japan; Kazakhstan; Kiribati; Republic of Korea; Kyrgyz Republic; Lao PDR; Macau, China; Malaysia; Maldives; Marshall Islands; Federated States of Micronesia; Mongolia; Myanmar; Nauru; Nepal; Pakistan; Palau; Papua New Guinea; Philippines; Samoa; Singapore; Solomon Islands; Sri Lanka; Taipei,China; Thailand; Tajikistan; Timor-Leste; Tonga; Turkmenistan; Tuvalu; Uzbekistan; Vanuatu; and Viet Nam.

2

imperatives. National action agenda Seven overarching inter-generational issues and strategic changes require action at the national level

“

Seven overarching multigenerational

issues and strategic changes require action at the national level throughout the region

Figure 1

Strategic framework

Financial transformation As its share of global GDP rises to 50 percent or more, Asia should also have about the same share of global financial assets, the banking sector, equity and bond markets etc. In transforming its financial systems, Asian leaders must remain mindful of the lessons of the 1997 Asian Financial Crisis and the Great Recession (sometimes also referred to as the

National Action

Global Agenda

Global Financial Crisis) of 2007–09. Above all, Asia must avoid falling prey to another bubble of exces-

EXECUTIVE SUMMARY AND CONCLUSIONS

Regional Cooperation

sively exuberant expectations. It will need to formulate its own financial model, avoiding both the overreliance on self-regulation by markets—that caused the Great Recession—and the current excessive central government control of banking dominated financial systems

throughout the region:

in many parts of Asia, and becoming more open to institutional innovation. There is also an urgent need to

Growth with inclusion

develop financial instruments and create an enabling environment for financing Asia’s massive infrastruc-

Growth and inclusion need not be mutually exclusive;

ture and urbanization needs through public-private

indeed they can be mutually reinforcing. To sustain

partnerships and public financial markets. In Northeast

growth over the long-term, almost all Asian countries

Asia (Japan, Republic of Korea and PRC), the special

must give much higher priority to inclusion and reduc-

needs of ageing societies demand greater attention.

ing inequalities—rich/poor, rural/urban, educated/

National reforms should create conditions to facilitate

uneducated and along ethnic lines. Countries should

regional (and global) financial integration at the right

give highest priority to education and developing hu-

time.

man capital, with a focus on women, essential to fully realize the demographic dividend. Increasing access

Managing massive urbanization

to quality infrastructure services will be important. Urban inequality, which has been rising in parts of

Between now and 2050, Asia will be transformed as

Asia, will need to be addressed. Rural development—

its urban population nearly doubles from 1.6 billion

including agriculture—will remain important in all low

to 3.1 billion, truly staggering and truly historic (Table

and middle income economies to uplift millions of

1). Asia’s cities, which already account for more than

Asians still resident in rural areas. However, rural de-

80 percent of economic output, will be the centers

velopment is not an alternative to urban development.

of higher education, innovation and technological

They complement each other.

development. Urban buildings and transport would account for the bulk of energy consumption and carbon emissions. The quality and efficiency of urban areas will thus increasingly determine Asia’s long-term 3

“

In the future, the converging Asian

economies and, particularly, PRC and India must move from catch-up to frontier entrepreneurship and innovation

EXECUTIVE SUMMARY AND CONCLUSIONS

competitiveness and social and political stability. Asia

It will be most affected by, and most responsible for,

must take advantage of being early on its urbanization

excessive reliance on energy imports. To preserve

growth curve, to manage its coming rapid urbaniza-

its economic interests, it will need to take the lead in

tion by promoting compact, energy-efficient, safe

radical energy efficiency and diversification programs

and livable cities—more reliant on mass transit than

based on eliminating energy subsidies and switching

on cars. It must also manage some significant risks,

from fossil fuels to renewable energy4. There will be

particularly those associated with inequality, slums

similar issues for most other natural resources, includ-

and a breakdown of social cohesion. Better financ-

ing water and fertile land for food production. The only

ing and management of cities will require long-term

way out is a combination of price increases, techno-

planning and visionary leadership, further decentraliza-

logical breakthroughs and changes in consumption

tion of responsibility to local governments, more local

patterns. Note the strong synergy between energy

accountability and greater market financing of urban

efficiency and total factor productivity growth, which is

capital investments.

needed for sustained global competitiveness. The key policy implication for all Asian countries is that their fu-

1

ture competitiveness and well-being will depend heav-

Asia’s urban population will nearly double by 2050

ily on improving the efficiency of natural resource use and winning the global race to a low carbon future.

Asian Urbanization

2010

2050

Total Urban Population (millions)

1,649

3,247

Entrepreneurship, innovation and technological

Northeast Asia

805

1,284

development

South Asia

496

1,261

Southeast Asia

252

520

The continuing rapid growth of Asian economies

Central Asia

96

182

over the next 40 years will require harnessing the

Urbanization (%)

41%

64%

full potential of technology, innovation and, critically,

Northeast Asia

50%

74%

entrepreneurship. The model in Asia so far, with few

South Asia

30%

55%

exceptions, has been “catching up” with the more

Southeast Asia

42%

65%

advanced economies and adapting the technologies

Central Asia

52%

67%

developed there to produce for western markets. That

Source: UN World Urbanization Prospects, 2007 Revision.

is no longer adequate. More Asian countries need to emulate Japan, Singapore and Republic of Korea and come closer to, or preferably become, the global best practice. In the future, the converging Asian econo-

Radical reduction in the intensity of energy and

mies and, particularly, PRC and India must move from

natural resource use

catch-up to frontier entrepreneurship and innovation to create breakthroughs in science and technology,

The anticipated affluence of some 3 billion additional

joining the ranks of Japan, Republic of Korea and

Asians will put tremendous pressures on—and create

other high-income economies. A particularly fruitful

intense competition for—Earth’s finite natural resources. Long before 2050, Asia will surpass North America and Europe as the largest energy consuming block. 4

4 It is still too early to assess as to how the March 2011 nuclear incident in Japan would affect the future role and prospects of nuclear energy.

“

High quality institutions will help the fast

growing countries avoid the Middle Income Trap

Asia to understand what can be done to improve well-

strated notable successes, will be frugal innovation

being and what that implies for the region’s growth

to meet the needs of millions of people with modest

model. It may be time to begin defining measures of

incomes or the so called bottom of the pyramid. The

well-being and incorporating them in national surveys.

core requirement—where many Asian economies fall short—is quality education at all levels that promotes

Priorities for national action

creativity, supported by an eco-system necessary to foster innovation and entrepreneurship.

While these inter-generational issues apply to most Asian economies, their relative priority will vary over

Governance and institutions

time, depending on the group a country belongs to at a given time:

EXECUTIVE SUMMARY AND CONCLUSIONS

area, where PRC and India have already demon-

All countries must improve governance and continually transform their institutions. The recent deterioration

Slow or modest growth, aspiring Asia

in the quality and credibility of national political and economic institutions (illustrated by rising corruption) is

The highest priority of this group—which includes both

a serious concern and likely to become a binding con-

low5 and lower-middle6 income economies ranging

straint to growth. High quality institutions will help the

from Nepal to Tajikistan—must be to raise economic

fast growing countries avoid the Middle Income Trap,

growth to approach those of their more successful

and the slower growing countries establish the basic

Asian neighbors. They should aim at joining the group

institutions for moving toward sustained economic

of convergers7 by focusing on the fundamentals of

growth. Managing the common challenges—be they

development: promoting faster and more inclusive

rapid urbanization, building a fundamentally sound

growth by reducing inequalities through better educa-

financial sector, or fostering entrepreneurship and in-

tion for all, infrastructure development and major im-

novation—requires effective governance, both at the

provements in institutions, the business environment

central and local level. Asia must modernize gover-

and openness to external markets.

nance and retool its institutions with an emphasis on transparency, accountability and enforceability

Fast-growing converging economies

From growth to well-being

Avoiding the Middle Income Trap should be the paramount objective of the fast growing economies. They

As more countries emulate the past economic suc-

should—in addition to further reducing inequalities and

cess of Japan, Singapore and Republic of Korea and

consolidating the fundamentals of development—train

become high income, they will need to move toward

a world-class skilled labor force and build credible

new policies that promote broader social well-being,

and predictable institutions that protect the property

self-satisfaction and happiness. Just as inclusion will

(physical and intellectual) rights and allow fair dispute

be important to maintain social cohesion and political

resolution. Constantly improving the business climate

stability in low and middle income countries, a greater focus on personal satisfaction and harmony with nature, rather than more wealth, will be important for the affluent countries. This requires a dialogue within

5 Per capita income of less than US $995. 6 Per capita income between $996-$3945. 7 Economies that have successfully converged with high income economies over an extended period (25 years plus) through productivity gains.

5

“

Regional cooperation and integration are

critical for Asia’s march towards prosperity

EXECUTIVE SUMMARY AND CONCLUSIONS

will be key. In addition, they will need a new vision in

Throughout Asia, an expanding middle class—itself a

four crucial areas: to transform their financial systems

desirable product of rapid socioeconomic growth—will

to support development of the real sector while pro-

also exert new demands for greater voice and partici-

moting stability and minimizing volatility in the markets;

pation, greater accountability for results, and greater

to manage the challenges of rapid urbanization; to

personal space. The quality of communication and the

dramatically improve the efficiency of energy use and

mutual respect between those who govern and those

other natural resources; and to promote innovation

who are governed will become paramount as new

and entrepreneurship for enhanced productivity and

social media and other yet unknown tools will be avail-

competitiveness.

able to the public, as recent events in the Middle East have amply illustrated.

High income, developed economies Although daunting, the eradication of corruption is This group—especially Japan, Republic of Korea and

critical for all countries to maintain social and political

Singapore—should lead the rest of Asia in two par-

stability and retain legitimacy.

ticular areas. First, through scientific and technological breakthroughs in areas of special importance to Asia,

Regional cooperation and collaboration

such as biotechnology, medical care for the aged and mitigating climate change. And second in moving be-

Regional cooperation and integration are critical for

yond achieving high economic growth toward promot-

Asia’s march towards prosperity. Greater regional

ing broader social well-being and happiness.

cooperation and collaboration will become significantly more important for six reasons. First, cementing Asia’s

As countries develop and their institutional capacities

hard-won economic gains in the face of vulnerabili-

improve, they will graduate from their current country

ties to external shocks. Second, regional coopera-

grouping to the next—from non-convergers to con-

tion and collaboration could be an important bridge

vergers, and from middle income convergers to high

between individual Asian countries and the rest of

income8

the world, and also as leverage for policy makers to

or developed economy leaders.

implement domestic reforms that face resistance from Asia’s high income countries and even some middle

entrenched interest groups. To have its voice and influ-

income countries such as PRC face the singular chal-

ence commensurate with its economic weight, Asian

lenge of ageing—of the very generation that created

economies will need to coordinate, even harmonize,

the Asian miracle. These demographic realities will

their geopolitical positions on a range of global issues.

not only translate into new (more modest) economic

This can be done only through genuine and regular re-

realities, but also into new inter-generational expecta-

gional dialogue and cooperation. Third, as Asian econ-

tions and relations. These in turn will affect all aspects

omies rebalance growth towards “internal” (domestic

of governance and call for wide-ranging institutional

and regional) demand, transport and energy connec-

adjustments, raising issues of fiscal affordability and

tivity will pave the way for creation of a single market.

sustainability.

To sustain regionwide economic growth, they need to fully open their markets to neighbors in the region (in the same way the US and European markets have

8 Per capita income of $12,196 or more.

6

been open to Asia since World War II). This will allow

“

The region will need to take greater

ownership of the global commons, including an open trading system, stable financial system, climate change, and peace and security

Crucial for increased regional cooperation is strong

labor mobility, particularly of skilled labor) throughout

political leadership. Given the region’s diversity, build-

Asia. Fourth, regional cooperation and development

ing Asia’s regionalism would require collective leader-

assistance can help reduce cross-country disparities

ship that requires the recognition of adequate bal-

in income and opportunities, which if left unchecked,

ance of power among all participants. Major existing

could breed instability or even spark conflicts in parts

economic powers like Japan and Republic of Korea,

of Asia. Fifth, collaboration in technological develop-

as well as emerging ones such as PRC, India and

ment, energy security, and disaster preparedness can

Indonesia will have an important role in integrating Asia

yield significant synergies and positive spillovers. And

and shaping its role in the global economy.

sixth, skillful and cooperative management of regional commons will become increasingly important for

Global agenda

EXECUTIVE SUMMARY AND CONCLUSIONS

unhindered flow of trade and investments (and more

Asia’s long-term stability, peace and harmony. Asia’s growth and larger footprint in the global Avoiding conflict between mega economies and

economy will bring with it new challenges, responsi-

nuclear states, and maintaining social and political

bilities and obligations. The region will need to take

stability in the region will be paramount. Given its

greater ownership of the global commons, includ-

diversity and heterogeneity, Asia will need to develop

ing an open trading system, stable financial system,

its own unique model of regional cooperation and

climate change, and peace and security. It will need

integration that builds on the past positive experience:

to gradually transform from a passive onlooker in the

a market-driven, bottom-up and pragmatic approach

debate on global rule-making and a reticent follower of

that facilitates free regional trade and investment

the rules, to an active participant in the debate and a

flows. This model could build on the ASEAN experi-

constructive formulator of the rules. While formulating

ence and gradually include more economies over time,

its domestic or regional policy agenda, the region as

eventually resulting in unhindered flow of trade and

a whole, but also the larger economies—PRC, India,

investments throughout Asia as well as some labor

Indonesia, Japan and Republic of Korea—will need to

mobility. The aim of these spontaneous actions and

take into account the regional and global implications.

government initiatives is to accomplish the creation

The region will need to delicately “manage” its rapidly

of an Asian economic community. Such an approach

rising role as a major player in global governance in a

will require stronger—though not necessarily new—re-

non-assertive and constructive way. As an emerging

gional institutions.

global leader, Asia should act as—and be seen as—a responsible global citizen.

The creation of an integrated and effective Asian economic community must be based on two general prin-

In this context, Developing Asia’s stance on climate

ciples—openness and transparency. Openness will be

change requires a fundamental reassessment. This

a continuation of Asia’s long-standing policy of open

study demonstrates that early and aggressive action

regionalism. It also encourages regional institutions

on climate change is in Asia’s self-interest—socially,

to make the most of existing global institutions and

economically and politically. A change in its current

conventions. Meanwhile, transparency will enhance

stance will also be an early demonstration to the world

accountability and strengthen governance.

that Asia is willing and able to play a constructive role in preserving the global commons. 7

“

The agenda in this report—national,

regional and global—is broad ranging and requires far-sighted leadership

EXECUTIVE SUMMARY AND CONCLUSIONS

As Asia becomes the center of the global economy, it

the region realizes the opportunity that lies before it.

will be in its self-interest that the rest of world is also

Which and how many countries will meet this chal-

doing well economically and politically. Peace and

lenge? The answer is far from clear. Given this reality

security throughout the world will be essential for its

and uncertainties about the various drivers, the report

long-term prosperity.

postulates two quantitative scenarios with very different outcomes. The discussion above is based on the

Asia’s efforts to enhance regional cooperation must

optimistic Asian Century scenario. But this scenario is

not be at the cost of Asia’s traditional openness to the

by no means preordained.

rest of the world. Asia must adhere to its long standing strategy of “open regionalism.”

The Asian Century scenario assumes that: (i) the eleven economies with a demonstrated past record

Need for enhanced resilience

of sustained convergence to the best global practice over the past 30 plus years would continue to do so

Asia’s rise will almost certainly not be smooth. Eco-

over the next forty years; and (ii) countries accounting

nomic history teaches us that there will be many ups

for roughly forty percent of the GDP and population

and downs along the way. For example, in the past 40

of the remaining (currently non-converging, aspiring)

years, financial crises have reoccurred roughly once

economies would succeed in becoming convergers

every 10 years. It is most likely that between now and

by 2020. This will significantly raise their economic

2050, there will be major crises: financial or economic

growth between 2020 and 2050, and bring their

(even social and political). How countries navigate

societies closer to affluence. Under this scenario some

through them will decide Asia’s fortunes. Fortunately,

3 billion additional Asians would become affluent be-

with each successive crisis, Asia has demonstrated

tween now and 2050. This should be considered the

a growing capacity to manage crises. The region’s

desired or ideal scenario for Asia as a whole.

much enhanced resilience to external shocks was demonstrated vividly during the Great Recession, as it

The Middle Income Trap scenario, assumes that the

became the first region to recover, with a V-shaped re-

current converging economies would fall into the Mid-

covery. But the region must not become complacent.

dle Income Trap in the next 5-10 years, without any of

It must continue to reinforce its resilience by following

the current non-convergers improving upon their past

prudent macro-economic, fiscal and monetary policies

record; in other words, Asia would follow the pattern

and by making its financial systems more robust.

of Latin America over the past 30 years. This could be

Overall, the adaptability, flexibility and capacity to

treated as the pessimistic scenario and a wakeup call

respond to the changing global economic landscape

to Asian leaders.

will carry a high premium. Long-term projections of Asia through 2050 cannot Asian Century vs. Middle Income Trap sce-

rule out the possibility of a “perfect storm” scenario,

nario: dramatic difference in outcome

whereby the combination of bad macro-policies, exuberance combined with lax financial sector supervi-

8

The agenda in this report—national, regional and

sion, conflicts, natural disaster/climate change risks,

global—is broad ranging and requires far-sighted

demographic and weak governance could lead to

leadership. It is daunting but also necessary that

a major setback to Asian growth. Under this worst

“

If today’s fast-growing Asian economies

become mired in the Middle Income Trap, Asia would fall far short of the Asian Century

case—or Doomsday—scenario, Asia could stumble

The intangibles

into a financial meltdown, major conflicts or regionFour overriding non-tangibles will ultimately determine

to quantify the scenario, clearly Asia must be aware of

Asia’s long-term destiny. First is the ability of Asia’s

such a catastrophic situation and avoid it at all costs.

leaders to persevere during the inevitable ups and

There will be a huge difference in the outcomes under

downs and to focus on the long-term. Implementing

the two scenarios quantified here. The economic and

the vision, strategy, policies, and institution building

social costs of missing the Asian Century are truly

proposed here will place a tremendous premium on

staggering. If today’s fast-growing Asian economies

mature, far-sighted and enlightened leadership. The

become mired in the Middle Income Trap, Asia would

region’s ability to maintain the current momentum for

fall far short of the Asian Century. Total GDP in 2050

another 40 years, which will require continual adjust-

would reach only $61 trillion, not $148 trillion (at

ments in strategy and policies to respond to changing

market exchange rates) (Figure 2). GDP per capita

circumstances and shifting comparative advantages.

would be only $20,300, not $38,600, in PPP. Such an

Second, will be the willingness and ability of all Asians

outcome would deprive billions of Asians of a lifetime

to emulate the success of East Asia to adopt a so far

of affluence and well-being.

pragmatic rather than ideological approach to policy

Box 2

EXECUTIVE SUMMARY AND CONCLUSIONS

wide chaos well before 2050. While it is not possible

The Middle Income Trap: unable to compete

The Middle Income Trap refers to countries stagnating and not growing to advanced country levels. This is illustrated in the figure, which plots countries between 1975 and 2005. In a steadily growing economy, the per capita GDP would rise continuously over time, towards higher incomes. That is the experience of Republic of Korea. But many middle income countries do not follow this

GDP per capita ($)

the per capita incomes of three middle income 18000 Republic of Korea 15000 Avoiding the middle income trap 12000

9000

pattern. Instead, they have short periods of growth followed by periods of stagnation or even decline,

6000 Brazil

or are stuck at low growth rates. They are caught in the Middle Income Trap— unable to compete with low income, low wage economies in manufacturing exports and unable to compete with advanced economies in high

3000 South Africa Caught in the middle income trap 0 1975

1980

1985

1990

1995

2000

2005

Source: IMF World Economic Outlook, October 2010.

skill innovations. Put another way, such countries cannot make a timely transition from resourcedriven growth, with low cost labor and capital, to productivity-driven growth. 9

“

Implementing the vision, strategy, policies,

and institution building proposed here will place a tremendous premium on mature, far-sighted and enlightened leadership

Figure 2

Asian Century vs. Middle Income Trap Asian Century Scenario

EXECUTIVE SUMMARY AND CONCLUSIONS

Sub Saharan Africa 2%

Middle East & North Africa 3%

Rest of World 1%

Middle Income Trap Scenario Middle East & North Sub Saharan Africa 5% Africa 3%

Europe 18%

Europe 26%

Asia 51% Lan America & Caribbean 10%

North America 15%

Lan America & Caribbean 9%

Asia GDP: $148 trillion

Rest of World 2%

Asia 32% North America 23%

Asia GDP: $61 trillion

Source: Centennial Group projections.

formulation and to keep a laser like focus on results.

The changes in policies and strategies proposed here,

Third is Asia’s success in building much greater mutual

and related institutional reforms, have long gestation

trust and confidence between the major economies,

periods spanning many decades. The future—2050—

vital for effective regional cooperation and collabora-

will be here before we know it, and Asian leaders must

tion. And fourth is the commitment and ability of Asian

begin to act now.

leaders to modernize governance and retool institutions, while enhancing transparency and accountability.

10

Background and Introduction

1 What is “Asia”?

premium on education, the work ethic and a sense of broader common good.

Asia is an expansive and heterogeneous region—

The promise of rapid economic growth and the

physically, socially, politically and economically. It

ability to realize such aspirations was first evidenced

includes some of the world’s largest, most competi-

by Japan’s transformation to a rich country within

tive and most sophisticated economies, such as

the span of a generation (a feat since emulated by

Japan, Hong Kong, China, Singapore and Republic

Republic of Korea, Taipei,China, Hong Kong, China

of Korea. People’s Republic of China (PRC), India,

and Singapore). Malaysia and Thailand, once among

Indonesia, and Viet Nam are fast emerging as impor-

the poorest, have solidly established themselves

tant global players. They co-exist with numerous

as upper-middle income countries2. And two of the

small, under-developed and, often, fragile economies

region’s largest countries, PRC and India, are now

such as Afghanistan, Nepal and many Pacific Islands.

advancing at an impressive pace to join the ranks of

There are vast differences and—until recently—

the rich. Indonesia and Viet Nam are growing rapidly.

only limited physical and economic links among the

It is therefore no surprise that all of Asia, despite its

three subregions: East Asia and the Pacific, South

heterogeneity, aspires to emulate these success

Asia and Central Asia. Unlike the atmosphere of

stories.

shared ancestry in Europe, Asian nations are not

When considering Asia’s economic and social

linked by a common history, culture, religion or herit-

prospects and challenges, it is important to keep in

age. Asians speak dozens of languages without a

mind the many paradoxes that abound in the region.

common root, such as Greek or Latin, the basis of

While it is the world’s fastest growing region, Asia is

most European languages. Often, individual Asian

still home to nearly half of the world’s absolute poor

countries have stronger economic and social ties with

(with per capita incomes of less than US$1.25 a day).

nations outside Asia than with those within the region.

Asia has become the global hub of manufacturing

So, what is Asia? The notion that, given its size

and information technology services, and yet vast

and diversity, it is merely an idealistic concept incor-

numbers of its people are illiterate or unemployed.

porating distinct subregions and peoples rather than

The rapid ageing of societies is a particular concern

a homogeneous entity is not correct. Today’s Asia,

in Japan, Republic of Korea and PRC, while Pakistan,

even with its geographical, political, linguistic and cul-

the Philippines and many Central Asian republics

tural diversity, shares one overriding common trait—

still have high population growth rates. The region

the pursuit of rapid economic and social development

is home to the largest savings pool in the world and

encompassing almost 60 percent of the world’s cur-

the largest net lender to the developed countries,

rent population.1 All Asian societies also place a high

but it simultaneously has massive unmet investment needs at home—particularly in infrastructure and

1 In this study, Asia is defined to comprise three Asian subregions; East Asia and the Pacific (including Democratic People’s Republic of Korea); South Asia; and Central Asia (including Iran). The 49 developed economies covered are: Afghanistan; Armenia; Azerbaijan; Bangladesh; Bhutan; Brunei Darussalam; Cambodia; People’s Republic of China (PRC); Cook Islands; Democratic People’s Republic of Korea; Fiji; Georgia; Hong Kong, China; India; Indonesia; Iran; Japan; Kazakhstan; Kiribati; Republic of Korea; Kyrgyz Republic; Lao PDR; Macau, China; Malaysia; Maldives; Marshall Islands; Federated States of Micronesia; Mongolia; Myanmar; Nauru; Nepal; Pakistan; Palau; Papua New Guinea; Philippines; Samoa; Singapore; Solomon Islands; Sri Lanka;

urbanization. And in contrast to its superiority in manufacturing and information technology services, Asia’s financial sector is underdeveloped; it is more

Taipei,China; Thailand; Tajikistan; Timor-Leste; Tonga; Turkmenistan; Tuvalu; Uzbekistan; Vanuatu; and Viet Nam. 2 Per capita income between $3,946-$12,196.

11

“

Amidst the excitement about the

transformations taking place in Asia, it is also important to recognize that Asia faces a number of mega challenges

1

efficient to intermediate its savings in European and

20005, a rate that doubles incomes in 20 years.

North American financial centers than to rely on its

Four of the top five performers in the most recent

own financial markets.

OECD Program for International Student Assessment

BACKGROUND AND INTRODUCTION

Despite these paradoxes, the speed and extent of

(PISA) are Asian: Shanghai-PRC; Republic of Korea;

Asia’s economic and social progress during the past

Hong Kong, China; and Singapore.6 Japan, PRC

40 years is undeniable. Indeed, it remains unprec-

and Republic of Korea are among the top countries

edented. In many respects, the region has become

in terms of number of patents registered by the

an object of global envy.

World International Patent Office. The region’s quick

Asia is booming. On many dimensions, Asia’s

V-shaped recovery from the Great Recession of

development performance in the 21st century has

2007–09 is another indicator of Asia’s economic

been its best so far. The incomes in Developing Asia

prowess and resilience.

reached nearly $5,000 in purchasing power parity terms in 2010, growing 9.4 percent annually over the

Is the “Asian Century” preordained?

decade 2001-2010. Investment rates reached record highs, averaging 35 percent of GDP over the decade, suggesting enormous confidence in the region’s

about the “Asian Century.” The impression has been

future. The average annual growth of exports was

created that the ascendency of Asia is somehow an

11.4 percent. Net inflows of private capital into the

immutable fact and the only question is merely when

region averaged $83 billion a year. External debt fell to

PRC and India will become the largest and second

14.5 percent of GDP. And foreign exchange reserves

largest global economies, as if the countries are on

of $3.5 trillion were accumulated in Developing Asian

autopilot, gliding smoothly to their rightful destiny.

countries alone.

Amidst the excitement about the transformations

By some estimates, Asian countries could have

taking place in Asia, it is also important to recognize

reduced poverty ($1.25 a day) by 430 million people

that Asia faces a number of mega challenges: (i) large

between 2005 and 2010, 93 percent of the global

and, in some cases, rising inequities and disparities

poverty reduction in this time

frame.3

By all accounts,

within countries that could alter the political and

Asia is increasingly becoming a middle income

social fabric of the region; (ii) the risk of falling into the

region. According to the IMF, only seven Asian coun-

Middle Income Trap due to a host of economic, social

tries4

and political challenges faced by individual countries;

had per capita incomes of less than $1,000 in

2010. The aggregate numbers are of course heavily

12

Given all this, it has become fashionable to talk

(iii) intense competition for finite natural resources (energy, other minerals, water and fertile land) that

influenced by Asia’s two population giants, PRC and

would be unleashed in the next 40 years as some 3

India, but development performance is impressively

billion additional Asians become much more affluent

broad-based. Eleven Developing Asian countries

and strive to achieve even higher living standards; (iv)

have grown at more than 3.5 percent per capita since

the potential sharp rise in disparities across countries

3 L. Chandy and G. Gertz, “Poverty by the Numbers,” Washington, DC: Brookings Institution, January 2011. 4 Afghanistan, Bangladesh, Cambodia, Lao PDR, Myanmar, Nepal and TimorLeste.

5 The 11 countries are: Afghanistan, Bangladesh, Cambodia, PRC, India, Indonesia, Lao PDR, Maldives, Myanmar, Sri Lanka, and Viet Nam. Data from IMF World Economic Outlook, October 2010. 6 PISA 2009 Results, OECD (2010). PISA assesses reading, mathematics and science skills for 15-year olds.

“

In addition there is the

overarching challenge of governance, improvements in which will be the key to overcoming all other challenges

and subregions if the past differentials in relative

These challenges are not mutually exclusive. They can impact one another and multiply existing tensions,

turn would destabilize the countries and subregions

unrest, and conflicts, or even create new pressure

concerned; and (v) global warming and climate

points within and across Asia that threaten its growth,

change. The risks arising from climate change and

stability, and security. If the inter-generational issues

associated water shortages extend not only to the

highlighted in this report are not addressed, many

vast populations that inhabit coastal areas but also

in a collaborative and collective manner, there is an

to areas that rely heavily on agricultural production.

increased risk of failure.

Increased incidence of natural disasters could affect vast numbers of people throughout Asia. In addition there is the overarching challenge of

The study highlights these issues. Its central message is that while Asia is in the midst of fundamental economic and social changes, its sustained progress

governance, improvements in which will be the key

for another 40 years is far from preordained. Asians

to overcoming all other challenges. If current adverse

face formidable challenges in their quest for the

trends in the quality of institutions and in rising cor-

promise of an Asian Century.

ruption continue unchecked, the ability to sustain the growth momentum would be severely jeopardized. Asian countries thus face a long list of challenges that must be tackled at the national and/or regional

1 BACKGROUND AND INTRODUCTION

growth rates continue between now and 2050 that in

Its leaders must be aware that its future prosperity will need to be earned, in the same way that developed economies today earned their success over the past 40 years. Indeed, Asia controls its own destiny.

level if individual countries are to realize the promise and sustainability of rapid economic growth.

13

Asia in the Global Economy during 1750-2010: Setting the Scene 2 This chapter briefly traces Asia’s economic

Asia started to re-emerge after 1950, spurred

footprint starting in the 18th century. The 1750-1990

by Japan. This was followed by the rise of the

period saw Asia’s share of the global economy

newly industrialized economies and (NIEs)1—Hong

decline from about 60 percent to less than 20 per-

Kong, China; Republic of Korea; Singapore; and

cent. The two recent decades have witnessed the

Taipei,China. Starting in the 1980s first Malaysia and

beginning of a re-emergence as Asia reached 27

Thailand, then PRC, followed by India, Indonesia and

percent of global output.

Viet Nam, gave this growth a further boost. Today, Asia accounts for 27 percent of global output (at mar-

Decline and re-emergence: 1750–1990 Many outsiders call Asia’s recent economic success the rise of Asia. A more accurate term to

ket exchange rates). Reaping of the globalization dividend: 1990–2010

describe this success is the re-emergence of Asia. Asia accounted for 58 percent of the world’s

In the wake of the Great Recession, there is a

economy before the Industrial Revolution in the mid-

tendency to forget the extraordinary global boom that

dle of the 18th century. In the following two centuries,

had come just before. Looking at the last 10 years

the West grew much faster and Asia’s share steadily

and at IMF projections for the next five years suggests

declined to a low of some 15 percent around 1952

that, even taking the recession into account, global

(Figure 1).

output is on a rising trend that should continue over the medium term (Figure 2). This is not surprising. As the share of rapidly growing emerging markets in

Figure 1

global output grows, so too does the average global

Asia’s share of global GDP has bottomed

rate. Trend growth in world GDP accelerated from 3 percent in 1990 to 4 percent in 2010, and based on

70%

IMF projections to 2015 is set to continue for the next five years at least.

60%

The same pattern holds for the developing countries of Asia (Figure 3). In 1990 trend growth was

50% 40% 30%

around 7 percent. By 2010 it had increased to around

Maddison

8.5 percent, and actual growth was above this trend IMF WEO

line. The period covers the major crisis in developing East Asian economies in 1997–98 and the smaller

20% 10%

Dot Com Crash of 2001 as well as the recent Great Recession. If not for these events the trend line would be even steeper, thanks largely to PRC’s continued

0%

Source: Maddison, Angus: Contours of the World Economy; IMF World Economic Outlook, October 2010. Data for 1750-1790 is in PPP and data for 1991-2010 is in market prices.

superior growth performance and India’s acceleration 1 This name was coined in 1970 when Hong Kong, China; Republic of Korea; Taipei,China; and Singapore were growing fast on the basis of rapid industrialization. Today, they are not “newly industrializing” and are heavily service oriented economies, but the name has stuck.

15

“

Large structural changes in the world

economy—spurred by globalization— are accelerating the pace of growth

Figure 2

World GDP growth rate is steadily increasing

of growth since 2004. But other dynamic emerging markets in the region—Bangladesh, Cambodia, Indonesia, Kazakhstan, Viet Nam—have also been growing strongly. Large structural changes in the world economy—

5

spurred by globalization—are accelerating the pace 4

of growth. These are being led by the integration of PRC into the world economy, which is symbolized by

3

its accession to the World Trade Organization in 2001, as well as through the opening of formerly closed

2

economies in the former Soviet Union and Eastern Europe. But globalization has not just been about

1

expanding the global marketplace. The rapid development and absorption of information, communication

0 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014

ASIA IN THE GLOBAL ECONOMY DURING 1750-2010: SETTING THE SCENE

6

GDP growth (%)

2

-1

Source: IMF World Economic Outlook, October 2010.

and transportation technologies have fostered faster growth, allowing an ever more granular division of labor, extending beyond goods markets into services. Indeed, service exports have been the fastest growing component of global exports by a wide margin. Capital flows have also fueled globalization. Net private financial capital flows from rich to emerging economies between 1990 and 2010 totaled US$4.3

Figure 3

Developing Asia GDP growth, 1990-2015

trillion (2010 dollars). Even though a considerable part of this was returned to rich countries through foreign exchange reserve accumulation, the gross flows are

12

important. More recently, many emerging economies have themselves become major investors both in

10 GDP growth (%)

rich countries and in other emerging markets. They reflect the private sector’s business flows and a more

8

efficient global reallocation of capital. 6

One group of countries that has not seen growth accelerate despite globalization is the NIEs. Like

4

other countries that have rapidly converged with advanced country incomes, they have seen their

2

growth level off. In 1990 they were growing at 8 percent a year, but by 2010 this was cut in half. In 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014

0

Source: IMF World Economic Outlook, October 2010.

16

1990, their per capita income in purchasing power parity terms was $9,550, half that of advanced countries. By 2010, the Asian NIEs had income levels of

“

the period of globalization since

1990 has allowed Asia’s share in the world economy to grow fast

Figure 4

2

Trade is increasing in relevance 90

Trade as % of GDP

70 60 Asia

50

Lan America

40

EU-27 30 World 20 10 2008

2005

2002

1999

1996

1993

1990

1987

1984

1981

1978

1975

1972

1969

1966

1963

1960

0

Source: IMF Direction of Trade, 2011.

PPP$34,120, or 90 percent of the level of advanced

ASIA IN THE GLOBAL ECONOMY DURING 1750-2010: SETTING THE SCENE

80

Much of that has been due to Asians’ high saving

countries. Having come so close to the global best

rates and the resulting capital accumulation in Asian

practice economies, it is no surprise that their growth

countries. But much is also attributable to productivity

has slowed.

growth. Asian technology levels are catching up to

Taking all these trends together, the period of

those in the United States (US), and that catch-up is

globalization since 1990 has allowed Asia’s share in

reflected in high Asian growth rates. But the absolute

the world economy to grow fast. A small number of

levels of total factor productivity are still far lower in

Asian economies have converged toward advanced

Asia than in the US. This implies that most Asian

country incomes and the rapid growth of its develop-

countries have a long way to go before achieving con-

ing economies have allowed Asia to account for more

vergence with the US, and it is therefore premature

than a quarter of global output (about 27 percent). A

to believe that they have to grow more slowly in the

sharp rebound indeed from the mid 1950s.

same manner as the NIEs over the last 20 years.

17

3

Asia in the Global Economy 2011-2050: Main Drivers of the Asian Century This chapter discusses the main drivers of Asia’s

been converging in the past on a consistent basis.

economic and social transformation between now

They may have been growing faster than the United

and 2050. It first discusses the three classic drivers

States thanks to high levels of labor force growth

of economic growth: technological change, labor

and capital investment, but they have not shown

and capital. It then elaborates on three new drivers

sustained productivity growth. These countries will

of transformation particularly relevant to Asia: the

continue to have modest growth, especially once

emerging middle class; climate change; and the

favorable demographic forces reverse or capital accu-

communications revolution. Finally, it draws atten-

mulation starts to slow. However, they too can join the

tion to the emerging debate on growth versus social

convergers’ group through sustained improvements

well-being and personal happiness. These drivers are

in productivity.

not mutually exclusive. They are complementary and could be mutually reinforcing.

Of course, the global technology frontier itself is constantly being improved, by around 1.3 percent a year (See Annex 2). So even the rapid adopters

Classic drivers of growth

have considerable room to grow. By 2050 the global technology frontier could shift out by two-thirds. This

The basic dynamics of Asian growth depend

global advance means that converging countries

on three factors—technical progress (total factor

approach the frontier more slowly than otherwise. But

productivity growth), capital accumulation and labor

by the time they have absorbed today’s technology,

force growth. These factors fundamentally drive Asian

there are new possibilities to exploit (Figure 1).

growth, as well as growth in the rest of the world.

Modeling technological advancement in this way is highly stylized. The reality is that countries

Technological change and productivity

both adopt existing technology (adapt it to their own circumstances by changing production processes)

One way to view Asia’s growth potential is to

in some areas, and leapfrog in other areas. In Asia,

separate countries into three groups based on their

upgrading product lines (and discontinuing the out-

past performance. One group is the seven high

moded ones) is the most common form of technologi-

income developed economies. A second group of

cal progress, followed by introducing new product

countries has already demonstrated the ability to

lines or brand new technology.1

converge with the United States (taken here as repre-

Much Asian research and development is con-

sentative of what advanced countries have achieved

ducted by the business sector, shortening the time

in technological growth) and can be expected to

between new ideas and their adoption in new com-

continue to do so, albeit at a pace that slows as they

mercial ventures. Many Asian economies spend a

approach productivity levels in the United States.

higher proportion of their GDP on research and devel-

Eleven Developing Asian countries fall into this

opment than countries elsewhere. This is especially

converging category, with most of the largest econo-

pronounced in the advanced economies like Japan,

mies included (PRC, India, Indonesia, Kazakhstan,

Republic of Korea, Taipei,China and Singapore, but

Malaysia, Thailand and Viet Nam). A third group of 31 aspiring countries—mostly low income but also some lower middle income—has not

1 I. Gill and H. Kharas,“An East Asian Renaissance,” Washington, DC: World Bank, 2007.

19

“

Much Asian research and development is

conducted by the business sector, shortening the time between new ideas and their adoption in new commercial ventures

Figure 1

Asian total factor productivity (1990-2050) is converging with best practice

ASIA IN THE GLOBAL ECONOMY 2011-2050: MAIN DRIVERS OF THE ASIAN CENTURY

8.0 7.5 7.0

United States

6.5

PRC India

6.0

Rep. of Korea 5.5

Japan

5.0

Indonesia

4.5

Viet Nam

4.0 1990 1993 1996 1999 2002 2005 2008 2011 2014 2017 2020 2023 2026 2029 2032 2035 2038 2041 2044 2047 2050

3

Source: Centennial Group projections, 2011.

is also increasingly true for PRC. Most other Asian

Demographics and labor force

countries lag behind in this area. Asian technology has reached or is close to the

Over the last two decades, the world has benefit-

global cutting edge in many areas of electronics,

ted from a demographic dividend. The number of

computers, information technology services, com-

people aged 20–64, traditionally taken as the poten-

munications, drugs and biotech. The fact that in these

tial labor force, has been growing. In fact, about 560

areas technology is being increasingly developed in

million people were added to the global labor force

Asia promises technology’s spread to other Asian

in the 1990s, and almost 640 million more people

countries. Patent citations suggest that knowledge

between 2000 and 2010. That dividend is now slow-

spillovers are geographically concentrated. The

ing, and will lose steam by 2035.

closer to the source of the innovation, the faster its

Over the next several decades, an ever smaller

adoption. This might appear surprising in an age

absolute number of workers will enter the global labor

of freely flowing written information and access to

force, largely due to lower population growth rates

scientific journals. But it is consistent with the notion

in advanced and (some) emerging economies. By

that what is written down is only a small fraction of

2050, the global labor force will be essentially flat,

useful knowledge for firms. Tacit knowledge requires

growing perhaps by 0.4 percent. In reality, the actual

personal interaction to increase understanding and

labor force will reflect three offsetting trends. In some

dissemination.

countries, especially emerging markets, a far higher proportion of youth will go on to complete secondary school and get some tertiary education. Also, in countries such as India and Indonesia, the current

20

“

By 2050, Japan’s labor force could

be smaller than today’s by almost 30 million workers—a drop of one-third

Figure 2

Working age population (20-64) will begin to decline in all Asian subregions (1990-2050)

ASIA IN THE GLOBAL ECONOMY 2011-2050: MAIN DRIVERS OF THE ASIAN CENTURY

Source: UN World Population Prospects 2008 Revision.

large gap in the participation rates of males and

drop of one-third. Republic of Korea and Taipei,China

females would narrow, increasing the total number

are going through demographic transitions similar to

of workers. And, in advanced countries, more of the

Japan’s, but with a lag of 15-20 years. For both, the

elderly could remain in the labor force. Whether the

labor force is likely to peak in the next five years and

overall total labor force ends up expanding or con-

then start to decline. In these countries, the pace of

tracting depends on the size of these three trends. It

decline and the rate of ageing will be similar to that of

does seem clear, however, that the rate of increase

Japan: -1.3 to -1.5 percent a year.

that has helped power the global economy forward is set to decline.

The demographics of Asia’s giants—PRC and India—are very different. PRC is closer to the

Asia reflects these trends. Its labor force has

Northeast Asian countries. Its labor force is still grow-

been growing at 2.0 percent a year over the last two

ing, albeit more slowly than before, and will also prob-

decades. In the next two, that will be halved to 0.9

ably peak around 2020. India, by contrast, still has a

percent a year. In the two following decades (2031-

young population, and its labor force will continue to

2050), Asian labor force will likely become flat.

grow before reaching nearly one billion workers by

This aggregate conceals vast differences between

3

2050. India will then have 25 percent more workers

Northeast Asia, where the labor force is already peak-

than PRC. Today, it has 24 percent fewer workers.

ing and about to decline, and other parts of Asia still

This is one reason for India’s projected higher eco-

seeing robust growth (Figure 2). In Japan the labor

nomic growth than PRC over the longer term.

force peaked around 2000 and has been declining in absolute terms ever since, now losing about 800,000 workers a year. By 2050, Japan’s labor force could be smaller than today’s by almost 30 million workers—a 21

“

As PRC, India and other dynamic

Asian economies with high investment rates get richer, their absolute additions to the global capital stock will rise

3

Bangladesh, Kyrgyz Republic, and Kazakhstan are

Capital deepening

showing only 2-3 percent growth in the capital-labor Notwithstanding the huge investment rates of

ASIA IN THE GLOBAL ECONOMY 2011-2050: MAIN DRIVERS OF THE ASIAN CENTURY

countries like PRC and India in recent years, most

ratio. As economies get richer and more capital inten-

of the world’s capital stock—about 70 percent—is in

sive, it is harder to accumulate more capital. Simply

advanced economies. Small European economies,

maintaining net capital levels requires an increasing

like Switzerland, Norway, Denmark and Finland, have

proportion of investment to be used in replacing

the highest capital stock per worker in the world.

obsolete capital, leaving less to be added in new

Japan also has a capital stock per worker above the

machines. For rapidly growing economies, the rate of

developed country average.

obsolescence is also greater.

But it is in the emerging Asian economies where

The world is entering an investment boom. Today,

the growth of the capital stock per worker during the

$5 trillion is being added each year to the global capi-

past two decades has been the fastest, with PRC at

tal stock.2 In 20 years that could double to $10 trillion

8.6 percent, India 8.3 percent, Viet Nam 9.3 percent

annually, and by 2050 it could double again. Most of

and Cambodia 9.5 percent, among the fastest

this capital accumulation is in Asia (Figure 3). Already

anywhere. Another tier of Asian countries—includ-

about 45 percent of net additions to the world’s

ing Indonesia, Malaysia, Thailand, Turkmenistan,

capital stock are in Asia. As PRC, India and other

Singapore and Taipei,China—are deepening capital

dynamic Asian economies with high investment rates

at 5-6 percent a year, while the Philippines, Pakistan,

get richer, their absolute additions to the global capital

Figure 3

Asia will account for 70 percent of the world’s added capital stock between 2030 and 2050

500

Middle East & North Africa

450 Sub Saharan Africa

400

$ Trillions

350 Lan America & Caribbean

300 250

North America

200 Europe

150 100

Asia w/o Northeast Asia

50 Northeast Asia

0 1990-2010

2010-2030

2030-2050

Source: Centennial Group projections, 2011.

2 In 2007 dollars.

22

“

Consumption by the global middle

class accounts for almost one-third of total global demand, roughly divided evenly between North America, Europe and Asia

stock will rise. In five years, Asia will be contributing

Consumption by the global middle class accounts for almost one-third of total global demand, roughly

this trend continues, that proportion will be almost

divided evenly between North America, Europe and

three-quarters by 2050.

Asia, but heavily concentrated in advanced countries, which account for two-thirds of total middle class consumption (Table 1). These are the consumers at

The new drivers of transformation

risk of retrenching their demand. In the Asian Century In addition to the three classic drivers, Asia’s

scenario described in the next section, middle class

economic and social transformation will be driven by

consumption in advanced countries rises by only

three other significant trends: the emerging middle

0.6 percent a year for the next 20 years and then

class, the changing climate and the communications

declines. However, consumption by the global middle class

revolution.

could still expand vigorously thanks to the fast growing middle class in dynamic emerging economies,

The emerging Asian middle class

mostly in Asia (Table 2). Spending by the Asian midThe emerging middle class will become a key

dle class could rise 9 percent a year through 2030

driver of Asia’s economic growth because of the

(although Japanese middle class spending—one-third

demand for goods and services and because the

that of all Asia today—is forecast to rise by only 1

middle class is the source of savings and entrepre-

percent a year). This will be driven by the very strong

neurship that drives new products and processes.

growth in middle class spending in the large Asian

Growth in today’s advanced economies comes

countries—PRC, India and Indonesia.

mainly from new products, and most growth happens when these new products are targeted toward and adopted by the middle

1

class.3

3 ASIA IN THE GLOBAL ECONOMY 2011-2050: MAIN DRIVERS OF THE ASIAN CENTURY

half of the net increase in the global capital stock. If

This has already started with PRC. But its middle class is still small for an economy its size: no more than 12 percent of its people have living standards

The West currently accounts for the bulk of global middle class spending

Number of People (millions and global share) North America

338

18%

Europe

664

Central and South America

181

Consumption (billions PPPUS$ and global share) 5,602

26%

36%

8,138

38%

10%

1,534

7% 23%

Asia Pacific

525

28%

4,952

Sub-Saharan Africa

32

2%

256

1%

Middle East and North Africa

105

6%

796

4%

1,845

10,0%

21,278

100%

World Source: The Brookings Institution, 2010.

3 The middle class is defined here in the same way as in Kharas (2010) to include those living in households spending between $10 and $100 a day in purchasing power parity terms.

23

“

In the other dynamic Asian economies...

household incomes will expand by at least the growth rate of GDP and that this process will bring more households into the middle class

3

Table 2

The Asian middle class will grow sharply over the next 40 years

ASIA IN THE GLOBAL ECONOMY 2011-2050: MAIN DRIVERS OF THE ASIAN CENTURY

2030 Middle Class Population

Upper Class Population

PRC

1,120

40

India

1,190

15

2050 GDP per capita (PPP)

Middle Class Population

Upper Class Population

GDP per capita (PPP)

21,100

1,240

190

47,800

13,200

1,400

210

41,700

Indonesia

220

5

13,500

250

40

37,400

Japan

100

20

48,900

60

40

66,700

Republic of Korea

30

20

60,200

10

35

107,600

Viet Nam

80

2

11,900

100

15

33,800

World

4,990

580

19,400

5,900

1,500

36,600

US

185

190

65,500

120

290

98,600

Germany

50

30

51,300

25

50

77,800

Source: Centennial Group projections, 2011.

that would place them among the world’s middle

so that households do not need to set aside as much

class. PRC has made great strides in starting to

savings. Others are more immediate. The take-home

create a viable middle class. Housing ownership in

pay of a Chinese worker is only about two-thirds of

urban areas is over 80 percent, one of the highest

total compensation. The remainder is taxed by the

rates in the world. College enrollments climbed to 26

government through a variety of social insurance

million in 2009. Some 26 million automobiles were

costs, government mandated labor taxes, and insur-

registered in 2009, with sales of 13.6 million units in

ance for health, unemployment and the like.4 PRC

that year alone. By the end of 2008, 150 million credit

has the fiscal space to reduce these taxes using,

cards were in circulation. There are an estimated 700

perhaps, dividends and profits from state-owned

million cell phone subscribers. But these anecdotal

enterprises. If PRC achieves the new plan target of

data conceal the relative modest role of PRC’s mid-

increasing household expenditure at least as rapidly

dle class in the economy. In 2009, household final

as GDP, the size of its middle class will explode. By

consumption expenditure was only 35.7 percent of

2030, if growth continues and if households share in

GDP, well below the global average (61 percent) and

that growth, 75 percent of PRC’s population will enjoy

that of Viet Nam (66 percent), Indonesia (63 percent),

middle class standards, and $2/day poverty will be

India (54 percent) and Thailand (51 percent). It is also

substantially wiped out.

much lower than PRC’s historical share. Since 2000,

In the other dynamic Asian economies there is

consumption growth has averaged 2.5 percentage

even more reason to believe that household incomes

points less than GDP growth.

will expand by at least the growth rate of GDP and

PRC has long acknowledged the need to grow its

that this process will bring more households into the

domestic demand, but so far has been unable to do this. Some changes are long-term and structural, like improving public health and education and pensions 24

4 Bannister, J., “Manufacturing Employment and Compensation in China,” Washington, DC: US Department of Labor, Bureau of Labor Statistics, 2005.

“

Climate change is arguably the single most

important long-term issue of our lifetime

middle class. Combining growth with current income

While thousands of highly qualified and wellmeaning experts and institutions—both public and

the future size of the middle class and the growth

private—have already produced many outstanding

of its consumption for the next 20 years; in India (19

studies, there is no independent study analyzing the

percent), Indonesia (13 percent), Malaysia (7 percent),

economic self-interest of developing countries in Asia

Thailand (8 percent) and Viet Nam (19 percent). Low

(or worldwide).

income countries, like Cambodia, could also enjoy

To help bridge the wide gulf between the per-

rapid increases in middle class consumption but from

spectives of the developed and developing countries,

a very small base. Today, India has a tiny middle class

the Emerging Markets Forum commissioned an

by global standards. But if it continues its growth,

in-depth analysis of the economic impact of climate

70 percent of the Indian population could be middle

change on Asian developing countries. This analysis,

class within 15 years.

based on rigorous modeling of possible outcomes

These structural shifts in the pattern of global

under different scenarios to determine as to what is in

demand mean that Asia’s growth can rely increasingly

Asia’s best self-interest, is summarized below (Figure

on the markets of today’s Developing Asia rather

4).

than those of Europe, Japan or North America. If

The analysis makes clear that it is in Asia’s self-

Asian middle class consumers can substitute for

interest to move decisively on the global commons.

those in advanced economies, the Asian countries

Asia needs to do so not because the West is asking

will become major exporters to each other, emulating

it do so, but because it is purely and simply in Asia’s

the development path of Europe. European countries

own interest to do so.

are significant exporters, but largely to each other,

3 ASIA IN THE GLOBAL ECONOMY 2011-2050: MAIN DRIVERS OF THE ASIAN CENTURY

distribution parameters can be used to estimate

The analysis also makes clear that climate change

with Eurozone exports growing 4.5 percent a year

has far reaching implications for the way Asia needs

since 20005, notwithstanding the recent recession.

to move forward in its march toward prosperity:

Similarly, all Asian countries could benefit from rapid

dramatically increasing energy efficiency and reduc-

intra-regional growth without excessive reliance on

ing reliance on fossil fuels (both coal and petroleum);

the consumer markets of Europe or North America.

adopting a new approach to urbanization by building more compact and eco-friendly cities; relying much

Climate change

more on mass transit (over private cars) for urban dwellers and railways for long distance transport;

Climate change is arguably the single most impor-

giving priority to the development of related technolo-

tant long-term issue of our lifetime. It could affect

gies; and, perhaps more fundamentally, changing life-

each and every human being on our planet, irrespec-

styles to alleviate pressures on finite natural resources

tive of his or her country, income, or race. With over

by making a much more efficient use of them.

half of the world’s population residing in Asia and the

These interrelated aspects are critical for Asia’s

Pacific, Asians have more at stake in the well- being

long-term growth and development because the

of the planet than any other people.

future competitiveness and prosperity of nations will depend greatly on their efficiency in the use of natural

5 Leonardo Gasparini & Pablo Gluzmann, “Estimating income poverty and inequality from the Gallup World Poll: The case of Latin America and the Caribbean,” Palma de Mallorca, Spain: ECINEQ, Society for the Study of Economic Inequality, 2009.

resources and on progress in the low carbon race.

25

“

The recent events in Tunisia and Egypt

have demonstrated most vividly the power of the ongoing communications revolution on even the more traditional societies and politics

Figure 4

Asia should move decisively on the global commons because that is in its self-interest

ASIA IN THE GLOBAL ECONOMY 2011-2050: MAIN DRIVERS OF THE ASIAN CENTURY

Increase in temperature on 1990 leves expected by 2100, OC

3

The lines show the range between the

8

10th and 90th percentiles i.e. there is a

6.7

7

6.0

10% probability that the temperatures

6

could be higher than the range reported

5

and a 10% chance it could be lower.

4

3.5

3 2.6

2

2.3 1.6

1 0 Business as usual

Developed country Complementary Action + action by Developed Economies

High

Low

Median

Source: Vivid Economics and MAGICC, 2010.

The communications revolution

Indians. Similarly, there is an explosion in the penetration of the internet—not only in high income Japan,

The recent events in Tunisia and Egypt have demonstrated most vividly the power of the ongoing com-

income PRC and India. And the pace of change of

munications revolution on even the more traditional

this information revolution is only likely to accelerate in

societies and politics.

the next 40 years.

Satellites, television, mobile telephony and the

This has major economic implications for Asia

internet—leveraged by the new social media—have

not only by sharply reducing the cost of information

already revolutionized the way in which information

processing and sharing but also in the provision of

is gathered, stored, searched, shared and conveyed

both public and private services. Even more signifi-

within and across national boundaries (Table 4).

cantly, it could fundamentally alter the relationships

Witness the advent of Google, Facebook and Twitter.

between the public at large, civic societies, govern-

Until a few years ago, digital or electronic commu-

ments at all levels and private business. It has the

nications were primarily the preserve of the developed

potential of reducing the distance between the public

countries. In the past ten years this revolution has

and government. And with a much more educated,

also spread to the developing countries, especially

affluent and better informed citizenry, with middle

in Asia (Figure 5). Just 10 years ago, only 2-3 of

class values, in most Asian countries, there will be

1,000 Indians had access to a telephone (mainly

much greater demand for more transparent, honest

fixed lines). By the end of 2010, India had some 700

and responsive governance.

million mobile phone connections, two-thirds of all 26

Singapore and Republic of Korea—but also in middle

“

So far, Asian policymakers have emphasized

social stability as the foundation of economic growth. Many have thought of social stability and economic growth as a virtuous cycle

From growth to social well-being

Table 4

Internet usage is skyrocketing globally, picking up in Asia

So far, Asian policy makers have emphasized Many have thought of social stability and economic growth as a virtuous cycle. One underpins the other. That has certainly been Asia’s historical experience, but it may need reconsideration as Asian societies become more affluent between now and 2050.

PRC

India

Asia

2000

2007

Average % change (annual)

PRC

1.8

16.1

37%

India

0.5

7.2

46%

Internet Users (per 100 people)

Source: International Telecommunication Union ICT Indicators, 2010.

If governments could figure out what people really valued, they could construct better, more affordable social programs to maintain social harmony. But that is a complex process. For many years, the deficien-

Figure 5

cies of GDP as a measure of social progress or most convenient short-cut measure of well-being and hence the principal focus of policy makers has been on GDP growth. That is now starting to change in some rich countries. The first adjustment is to move toward the counting of non-monetary aspects of the quality of life. Amartya Sen’s capabilities approach focuses on the needs that must be met for people to fulfill their potential as human beings. In addition to money, they

Millions of subscripons

development have been known. Yet GDP remains the

Mobile phone subscriptions still have room for growth in PRC and India 5000 4500 4000 3500 3000 2500 2000 1500 1000 500 0

ASIA IN THE GLOBAL ECONOMY 2011-2050: MAIN DRIVERS OF THE ASIAN CENTURY

social stability as the foundation of economic growth.

3

may need education, health, a well-preserved environment and other amenities. Conditional on these,

World

PRC

India

however, more money expands people’s choice set, and hence expands their welfare. And if an individu-

Source: International Telecommunication Union ICT Indicators, 2010.

als’ welfare depends on the amount of money at their disposal, it follows that a nation’s welfare depends on the amount of money at the nation’s disposal, or

the basic psychology that differentiates personal

GDP.6 Thus the capabilities’ approach, in its simplest

satisfaction from income or material consumption—

form, can be reduced to adding a certain number

what is known as the Easterlin paradox. Easterlin was

of measurable social indicators like literacy, health,

the first economist to suggest that while “happiness”

income inequality, poverty, or environmental well-

within any country was clearly correlated with income

being into a nation’s calculus.

levels, the same did not appear to be the case across

These measures, however, might still not address

countries. Well-off countries need to focus on issues other than GDP per capita if they are to raise their citi-

6 This line of argument abstracts from distributional considerations, but those can be resolved, in theory, by appropriate government policy.

zens’ well-being. People may be more satisfied with less than with more. 27

“

a more reasoned and scientific dialogue

on what would do the most to improve Asians’ happiness might be worth exploring

3

This type of subjective preference measure is

ASIA IN THE GLOBAL ECONOMY 2011-2050: MAIN DRIVERS OF THE ASIAN CENTURY

what is measured by “happiness” surveys. In the

of measures relates to purpose in life and psychologi-

United Kingdom, to take one example, policy makers

cal well-being and includes questions on autonomy,

are considering three types of questions to ascertain

resilience, self-esteem, confidence and optimism.

happiness more

broadly.7

The first relates to the

In an era where Asia is testing the world’s limits

metrics of global life satisfaction or happiness as well

to unfettered GDP growth, a more reasoned and

as satisfaction within specific domains: health, crime,

scientific dialogue on what would do the most to

amount of leisure time, friendships, and family life.

improve Asians’ happiness might be worth exploring.

These evaluative measures can be particularly useful

Asia would not be alone in moving down this path.

to ask about how people feel about collective issues

The Stiglitz Commission has already recommended

like income inequality or quality of the environment.

that all national statistical offices incorporate subjec-

A second set of questions has to do with subjective,

tive measures of well-being into their national surveys.

cognitive evaluations of one’s daily life experiences,

Asian countries would do well to follow suit.8

including positive emotions such as joy and pride, and

7 Paul Dolan, Richard Layard, and Robert Metcalfe, “Measuring Subjective Well-Being for Public Policy: Recommendations on Measures”, London: Centre for Economic Performance, London School of Economics, 2010.

28

negative emotions like pain and worry. Yet a third set

8 Stiglitz, J. E., Sen, A. & Fitoussi, J. P., “Report by the Commission on the Measurement of Economic Performance and Social Progress,” Paris: OECD, 2009.

Asia in the Global Economy in 2050: The Asian Century 4 Based on the previous discussion of the main

Three country groups

drivers—both positive factors and major risks—it is possible to draw the broad contours of Asia’s poten-

Based on Asia’s economic record since 1990,

tial future trajectory through 2050. Given the major

it is possible to classify its 49 economies into three

uncertainties, this chapter does so by presenting two

groups:

plausible scenarios. But, it must be reiterated that

1.

High Income, Developed Economies (7)1:

these scenarios are by no means exhaustive, but only

These seven countries, led initially by Japan,

two possible rough trajectories of how the future may

triggered Asia’s reemergence starting in the

unfold.

1950s, first mastered the complex challenges

They have a limited objective: to draw attention to

involved in sustaining high productivity and

the longer-term implications of the broad trends and

economic growth over an extended period.

to ask what-if questions, rather than focus on specific

They successfully avoided the Middle Income

numbers or country ranking.

Trap, as they steadily moved from being low

The range of outcomes under the two scenarios is

income to middle income and, more recently,

intentionally very wide and demonstrates the potential

high income economies. By now, their produc-

payoff of proactive actions—or costs of inaction—by

tivity has essentially converged with the global

policy makers and business leaders.

best practice (US). Their per capita incomes and living standards now approach those of the developed economies in North America

Basic assumptions

and Europe. Asia’s rich economies still account for a significant fraction of its total economic

In developing any scenario, it is necessary to make some basic assumptions about the “givens” and to

output: $7.2 trillion, or 43 percent of the

do so explicitly. The scenarios presented below are

region’s total in 2010. For Asia, these econo-

based on the following key assumptions: (i) the world

mies are an important market, as well as the

in general (and Asia in particular) will continue to

frontier locations for much of the research and

remain peaceful and there will be no nuclear or other

innovation that occurs in the region. In fact, as

major armed conflicts; (ii) current national boundaries

the region becomes increasingly dependent

will remain unchanged; (ii) political transitions in Asia

on productivity growth, the relevance of the

will be peaceful and internal security will remain under

rich economies for the region will increase, not

control; (iv) the world will continue to have an open

decrease, even if the rate of growth of their

global trading system and a stable global financial

GDP remains well below that of the dynamic,

system; and (v) there will be effective global action on

converging Asian economies.

climate change. If any of these assumptions were not

2.

Fast Growing, Converging Economies (11):

to hold, there could be a catastrophic impact on Asia.

These countries, led by PRC and India, meet

It is not possible to quantify either the probability or

the Growth Commission’s criteria of sustained

cost of such events.

long-term success. Its Growth Report, along with many academic studies, concluded that 1 Brunei Darussalam; Hong Kong, China; Japan; Republic of Korea; Macau, China; Singapore; and Taipei,China.

29

“

Under this scenario some 3 billion

additional Asians would become affluent between now and 2050

4

development success could not be measured

countries, an econometric model (see Annex 2 for a

by performance over a single decade, but

summary description) is used to develop two sce-

by long-term performance—they suggested

narios of Asia’s economic trajectory between now and

ASIA IN THE GLOBAL ECONOMY IN 2050: THE ASIAN CENTURY

at least a twenty-five year

horizon.2

Most of

the countries in this group are middle income

3.

2050. 1.

Asian Century Scenario: assumes that: (i) the

countries and still vulnerable to the Middle

eleven economies with a demonstrated past

Income Trap. Their success in avoiding the

record of sustained convergence to the best

middle-income trap will determine whether

global practice over the past 30 plus years

they would join the first group of developed

would continue to do so over the next forty

economies in Asia by 2050. These countries

years; and (ii) countries accounting for roughly

account for 77 percent of Asia’s current popu-

forty percent of the GDP and population of the

lation and 51 percent of GDP.

currently non-converging (aspiring) economies

Slow or Modest Growth, Aspiring Economies

would succeed in becoming convergers by

(31): This is the largest group of economies in

2020. This will significantly raise their economic

Asia, encompassing both large and small, low,

growth between 2020 and 2050, and bring

as well as lower-middle income countries in all

their societies closer to affluence. Under this

three subregions: East Asia and Pacific, South

scenario some 3 billion additional Asians would

and Central Asia. Their average growth rate

become affluent between now and 2050. This

over the past thirty years has been well below

could be considered the desired or ideal scenario for Asia as a whole.

that of the second group. A few countries have shown occasional bursts of growth but they

2.

Middle Income Trap Scenario: assumes the

were followed by periods of stagnation or de-

current converging economies would fall into

cline. Some countries like the Philippines and

the Middle Income Trap in the next 5-10 years,

Sri Lanka exhibit the classic signs of the Middle

without any of the current non-convergers im-

Income Trap. While the number of countries

proving upon their past record; in other words,

in this group is large, their overall share of

Asia would follow the pattern of Latin America

Asia’s total population and GDP is modest,

over the past 30 years. This could be treated

18 percent and 6 percent, respectively. Yet,

as the pessimistic scenario and a wakeup call

improvements in their economic and social

to Asian leaders.

development are essential in order to reduce

Where exactly Asia ends up within the two sce-

the cross-country inequities and thus ensure

narios will depend on how effectively the region is able

the region’s long-term peace and security.

to tackle the policy and institutional agenda outlined in the following chapters. The end result will have a

The Asian Century

tremendous impact on the well-being and lifestyles of future generations of Asians, as well as societies

Taking account of the above mentioned drivers and the past performance of the three groups of

around the world. The remaining sections of this chapter discuss the outcomes based on the Asian Century Scenario. The

2 “The Growth Report, Strategies for Sustained Growth and Inclusive Development,” Washington, DC: Commission on Growth and Development, 2008.

30

implications of moving towards the Middle Income

“

Asia’s rapid growth implies

that by 2050 it could converge with average global living standards

Box 1

4

The engines of the Asian Century are the Asia-7 economies

55 percent of global GDP growth. They will thus be the engines of not only Asia’s economy but also the

fast growing middle income converging economies:

global economy.

PRC, India, Indonesia, Japan, Republic of Korea, Thailand and Malaysia. 2010 GDP (MER trillions)

These seven economies had a combined total population of 3.1 billion (78 percent of total Asia) and GDP of $14.2 trillion (87 percent of Asia) in 2010. Under the Asian Century scenario, their share of population by 2050 would be 73 percent and their GDP would be 90 percent of Asia. They alone will account for 45 percent of global GDP. Their average per capita income would be $45,800

2050 GDP (MER trillions)

PRC

5.7

62.9

India

1.4

40.4

Indonesia

.7

11.4

Japan

5.4

8.2

Republic of Korea

1.0

3.7

(in PPP) compared with $36,600 for the world as a

Thailand

.3

3.2

whole.

Malaysia

.2

2.6

14.8

132.4

Between 2010 and 2050, these seven

Total Asia-7

ASIA IN THE GLOBAL ECONOMY IN 2050: THE ASIAN CENTURY

Asia’s march to prosperity will be led by seven economies, two of them already developed and six

economies would account for as much as 87 percent of total GDP growth in Asia and of almost Source: IMF World Economic Outlook, October 2010; Centennial Group projections, 2011.

Trap Scenario are discussed in Chapter 15.

world, its share in global output will inexorably rise. The magnitudes are significant: by 2050, Asia’s output

Asia’s growing global footprint

footprint could be just over half that of the world. That would represent a doubling of Asia’s share

Under the Asian Century Scenario, Asia can be

to a level last seen in the early nineteenth century and

expected to steadily increase its global footprint. In

mean that Asia would account for 60 percent of the

2010, Asia accounted for about one-quarter of global

change in world output between 2010 and 2050, and

output (Table 1). It seems to have reached a rough

65 percent of the growth between 2040 and 2050.

equilibrium in its aggregate growth over the next forty

Small wonder then that so much business attention is

years at around 5.6 percent. This growth will not be

focused on Asian economies.

even: the advanced Asian country will slow, but the

Asia’s rapid growth implies that by 2050 it could

Developing Asian economies will compensate. Mean-

converge with average global living standards. Asia

while, even currently poor Asian economies should be

would no longer be a “poor” region, but an average

able to also achieve at least middle income levels. By

region, in income terms, with a range of advanced and

2040, it is unlikely that any Asian countries will be poor

middle income economies. On average, Asia could be

by today’s standards (per capita income of less than

about as prosperous as Europe today.

$995). As Asia grows more rapidly than the rest of the 31

4 ASIA IN THE GLOBAL ECONOMY IN 2050: THE ASIAN CENTURY

32

Table 1

The Asian Century: Asia will account for more than half of global output in 2050

2010

2020

2030

2040

2050

Global output (market exchange rates, US$ trillions)

62

90

132

195

292

Asian share of global output

27.4%

33.5%

38.9%

44.5%

50.6%

4.0%

3.9%

3.8%

3.6%

Global growth (prior decade ending in column year) Asia growth

5.8%

5.2%

4.8%

4.4%

Asian share of global growth

55.7%

59.3%

62.8%

66.0%

Global GDP per capita (PPP)

10,700

14,300

19,400

26,600

36,600

Asian GDP per capita (PPP)

6,600

10,600

16,500

25,400

38,600

Source: Centennial Group projections, 2011.

Realizing the Asian Century: Mega Challenges and Risks 5 This chapter discusses the major challenges and

and gained from the forces of globalization. Cities and

risks that Asia must overcome in sustaining its growth

coastal areas have benefited first, while interior regions

momentum and realizing the Asian Century. The re-

lag behind. Skilled workers have reaped a dispropor-

gion must confront five mega challenges. (i) large and,

tionate share of the gains from globalization. This has

in some cases, rising inequities and disparities within

led to large disparities within individual countries: for

countries that could alter the political and social fabric

example: between the coastal and western provinces

of the region; (ii) the risk of falling into the Middle In-

in PRC; eastern, southern, and western states in In-

come Trap due to a host of domestic economic, social

dia, east and west Java, north and south in Sri Lanka

and political challenges faced by individual countries;

and so on.

(iii) looming competition for finite natural resources

Countries in East Asia (and within PRC, the east-

(energy, minerals, water and fertile land) that would be

ern seaboard) are the most developed and prosper-

unleashed in the next forty years as some 3 billion ad-

ous parts of Asia. For Asia as a whole to become

ditional Asians become much more affluent and aim at

developed and to provide a satisfactory lifestyle to the

achieving higher living standards; (iv) potentially sharp

vast majority of Asians, the region must find ways to

rise in disparities across countries and subregions if

spread prosperity from the East to the West.

the past differentials in relative growth rates continue

Today, most Asian economies border other

between now and 2050 which, in turn, could destabi-

countries with whom they have similar income levels,

lize the countries and subregions concerned; and (v)

so inequality is still more of an issue for social stabil-

global warming and climate change coupled with the

ity within countries. Politically and socially too, it is

increased incidence of natural disasters could affect

imperative to minimize the disparities of incomes and

vast numbers of people living throughout Asia.

living conditions within countries. Otherwise, the large

In addition, almost all countries face the overarch-

(and growing) disparities will generate rising social

ing challenge of governance and institutional capacity,

dissatisfaction and threaten peace and stability. This,

improvements in which are a prerequisite for overcom-

in turn, would destroy the political support for the

ing all other challenges.

extraordinary discipline required to realize the vision of

These challenges are not mutually exclusive. They

the Asian Century.

can impact one another and multiply existing tensions, unrest, and conflicts, or even create new pressure

Middle Income Trap

points within and across Asia that threaten its growth, stability, and security. These challenges and risks are discussed below in turn.

Few countries sustain high growth for more than a generation, and even fewer continue to experience high growth rates once they reach middle income status (Box 1). Some features differentiating growth

Inequities within countries

beyond middle income from growth from low income to middle income are clear. Growth tends to become

Minimizing income disparities and other inequities

more capital intensive and skill intensive. The domes-

within countries will be a huge challenge that must

tic market expands and becomes a more important

be met. Many parts of Asia have seen significant

engine, especially for the growth of services. Wages

increases in intra-country inequality as they unleashed

start to rise, most rapidly for highly skilled workers, 33

“

A majority of Asian economies—

including PRC, India, Indonesia, and Viet Nam—still have to demonstrate their ability to avoid the Middle Income Trap

5

and shortages can emerge. The traditional low-wage

India, Indonesia, and Viet Nam—still have to demon-

manufacturing for export model does not work well

strate their ability to avoid this trap and the resulting

for middle income countries. They seem to become

slow growth experienced by much of Latin America.

REALIZING THE ASIAN CENTURY: MEGA CHALLENGES AND RISKS

trapped in a slow growth mode unless they change strategies and move up the value chain. Cost advan-

Competition for finite natural resources

tages in labor-intensive sectors, such as the manufactured exports that once drove growth, start to decline

Intense competition for scarce natural resources

in comparison with lower wage, poor country produc-

(energy, minerals, water and fertile land) that would be

ers. At the same time, middle income countries do not

unleashed with growth and exacerbated as some 3

have the property rights, capital markets, successful

billion additional Asians become increasingly affluent,

venture capital, or critical mass of highly skilled people

especially if they emulate current western lifestyles.

to grow through innovations as affluent countries do.

Global supply cannot readily accommodate changes

Caught between these two groups, middle income

in demand of this size, especially for non-renewable

countries can become trapped without a viable high-

raw materials. In that case, there is a zero-sum game:

growth strategy.

more for one economy means less for another. Can

A majority of Asian economies—including PRC, Box 1

Asian cities deliver water to their residents?1 Can the

The Middle Income Trap: unable to compete

The Middle Income Trap refers to countries stagnating and not growing to advanced country levels. This is illustrated in the figure, which plots countries between 1975 and 2005. In a steadily growing economy, the per capita GDP would rise continuously over time, towards higher incomes. That is the experience of Republic of Korea. But many middle income countries do not follow this

GDP per capita ($)

the per capita incomes of three middle income 18000 Republic of Korea 15000 Avoiding the middle income trap 12000

9000

pattern. Instead, they have short periods of growth followed by periods of stagnation or even decline,

6000 Brazil

or are stuck at low growth rates. They are caught in the Middle Income Trap— unable to compete with low income, low wage economies in manufacturing exports and unable to compete with advanced economies in high

3000 South Africa Caught in the middle income trap 0 1975

1980

1985

1990

1995

2000

2005

Source: IMF World Economic Outlook, October 2010.

skill innovations. Put another way, such countries cannot make a timely transition from resourcedriven growth, with low cost labor and capital, to productivity-driven growth. 34

1 In perhaps the most famous case, Fatehpur Sikri, the capital of the Mughal Empire, was abandoned in 1585 after only fourteen years because of water shortage.

“

The new equilibrium will surely be found in

a combination of adjustments: price increases to reduce demand and increase supply; new technologies to reduce unit consumption and/ or substitute with more plentiful, renewable resources; and recycling to minimize waste

gap between advanced economies and the least

provide enough food? How will Asia’s massive needs

developed is the largest of any region of the world. In

for energy and other natural resources be met? How

fact, income inequality in Asia is mostly explained by

would Asia sustain its rapid growth with limits on

differences between countries, in sharp contrast to

carbon emissions?

income inequality in Europe, North America or Latin

Such concerns about the sustainability of eco-

America, where most income inequality is within coun-

nomic growth are not new. They date back to Malthus

tries. As yet, Asia has given little thought as to how to

and re-emerge whenever growth is rapid. But there

manage inter-country inequality.

are new features to the debate today. First, there is

Two Asian borders already show very high dispari-

a backdrop of rapidly rising prices for food, fuel and

ties between countries. First, Democratic People’s

other raw materials. Higher prices signal scarcity in

Republic of Korea has lagged significantly behind Re-

spot markets and indeed commodity stockpiles seem

public of Korea and increasingly behind the Northeast

to be at lower levels than is comfortable for many gov-

region of PRC. Second, the income differential be-

ernments. While few formal long-term growth models

tween Singapore and Indonesia reached 14:1 in 2010.

include commodity prices as a factor in explaining the

In the future, as a growing number of individual Asian

pace of growth, conventional wisdom suggests that

countries grow rapidly, the border divisions could

growth could slow if prices surge further—if for no

sharply expand over time if their neighbors fall behind.

other reason than the need to invent new technologies

If India continues to grow fast, the ratio between its

to optimize resource use. Inevitably, the diffusion of

real income level and that of Bangladesh and Pakistan

any such technologies would be far slower than simply

could widen from today’s manageable 2.1 and 1.3,

adapting “off-the-shelf” technologies in a process of

respectively, to as high as 2.9 (India/Bangladesh) and

growth catch-up. What can Asia, as a region, do to

5.2 (India/Pakistan) by 2050. For comparison, the

make sure that the “adding-up” problems of today fol-

income ratio between the United States and Mexico

low the first cries of the Club of Rome in 1972 into the

today is 3.2 (in PPP terms). Other borders with high

dustbin of

history?2

The new equilibrium will surely be found in a combination of adjustments: price increases to reduce

5 REALIZING THE ASIAN CENTURY: MEGA CHALLENGES AND RISKS

region feed itself and, if not, will the rest of the world

income differentials between fast growing and slow growing Asian countries could emerge in Central Asia. Another factor changing the shape of Asia is that

demand and increase supply; new technologies to

borders are no longer confined by geography. Migra-

reduce unit consumption and/or substitute with more

tion has spread more broadly: Uzbek workers are in

plentiful, renewable resources; and recycling to mini-

many Central Asian countries; Bangladeshis in East

mize waste.

Asia and the Gulf. The Philippines has a long tradition of exporting skilled and unskilled labor all over the

Disparities across countries and subregions

world. When income differentials across borders rise to a significant degree, the chances are that migration,

Although most talk of Asian economics is upbeat, a number of Asian countries are falling well short of

either legal or illegal, will also rise in response. These trends suggest that Asia faces a consider-

their potential, largely in South and Central Asia. As

able risk if some countries are allowed to lag behind

discussed earlier, Asia is a region of paradoxes. The

while others enjoy the benefits of global and regional expansion. This is the argument for why Asia as a

2 Club of Rome. “The Limits to Growth” New York: Macmillan,1972.

whole should strive to achieve the Asian Century 35

“

Governance and institutional capacity are

the Achilles heel for most Asian economies

5

scenario.

Governance and institutional capacity

For the same reasons, this report recommends two initiatives under Asia’s regional cooperation

Governance and institutional capacity are the

REALIZING THE ASIAN CENTURY: MEGA CHALLENGES AND RISKS

agenda: (i) unhindered trade and investment flows

Achilles heel for most Asian economies. If recent

across all 49 Asian economies; and (ii) the launching

adverse trends in the quality of institutions and rising

of a meaningful intra-regional development assistance

corruption continue unchecked, the region’s ability to

program—on a bilateral or multilateral basis—consis-

realize the Asian Century would be seriously jeopar-

tent with Development Assistance Committee (DAC)

dized. All countries must improve governance and

guidelines.

continually transform their institutions to realize the promise of becoming affluent societies by 2050.

Global warming and climate change

Significant improvements in the quality and credibility of national political and economic institutions

Global warming and climate change, as well as

(illustrated by rising corruption) are prerequisites for

resultant severe water shortages, are mega challenges

sustaining Asia’s growth trajectory. High quality insti-

that have assumed global visibility relatively recently.

tutions will help the fast growing countries avoid the

But, it is perhaps the single most important long-term

Middle Income Trap, and the slower growing coun-

challenge facing humankind this century and beyond.

tries establish the basic conditions for moving toward

It could affect each and every human being on our

sustained economic growth. Managing the common

planet, irrespective of his or her country of residence

challenges—be they the delivery of quality social

or income level. With over half of the world’s popula-

and infrastructure services, the prevention of crony

tion residing in the region, Asians have more at stake

capitalism, rapid urbanization, building a fundamen-

in the well-being of the planet than any other people.

tally sound financial sector, fostering entrepreneurship

Mitigation of risks associated with climate change

and innovation, the protection of citizens’ rights or

and measures to adapt to global warming would af-

the maintenance of the rule of law—requires effective

fect every aspect of the economy and way of life of all

governance, both central and local.

Asians: from the efficiency of energy use and weaning

Asia will need to modernize governance and retool

away from fossil fuels, to modes of transportation, to

its institutions with an emphasis on transparency and

the design of buildings and indeed entire cities, to the

accountability.

care of forests and green areas; and, ultimately, to the need to transition to an economic growth model and

Mega risks

much more eco-friendly and sustainable lifestyles of future generations.

36

Amidst the excitement about the positive trans-

In addition to meeting these mega challenges,

formations taking place in Asia, it is often overlooked

Asia’s dramatically larger global footprint will bring

that some of the most violent conflicts since the end

new obligations and opportunities. The fact that Asia’s

of World War II (e.g., Korean War and Viet Nam War)

share of global GDP will not only exceed 50 percent

have occurred in Asia. More importantly, the world’s

but would also be more than twice that of the next

current hotbeds of conflict are concentrated in Asia.

largest geographic group (Europe) will fundamentally

In addition to these inter-country issues, a myriad of

alter its role and mode of interactions with the global

domestic conflicts/insurgencies are simultaneously

community.

occurring in the region’s small and big countries alike.

“

A major challenge that Asia faces is

whether it is going to develop the necessary mechanisms to mitigate regional conflicts and manage regional stability and order

Furthermore, one must take into account the distrust

Any one or a combination of regional or national conflicts can derail Asia’s growth trajectory—by far

tween the major countries. Finally, Asia is home to five

the biggest risk to the realization of the Asian Century

nuclear powers that have tense relations with others.

(Box 2).

Box 2

Risks of conflict in Asia

In the 1990s, Asia experienced a downward

regional security order is in a state of flux. Asia’s

trend in the number of conflicts—mirroring a similar

unprecedented economic boom has had major—

global trend. Sadly, it appears that the trend is now

but still unresolved—implications for how political

reversing, both globally as well as in Asia.

power will be distributed throughout the region; it

Several internal conflicts (where one or more ethnic group seeks to break up from an existing state) have been brewing intermittently. Recently,

is generally agreed that the best case scenario is a multi-polar Asia. This leads to the question of what might sustain

the Prime Minister of India described the Maoist

peace and order in a multi-polar Asia. Economic

insurgency in eastern and central India as the most

interdependence, a key driver for peace, is steadily

serious threat to India’s national security.

increasing in scope and scale in Asia, and serves

Beyond national boundaries, there have been

as a powerful force for mutual restraint in the

interstate conflicts that have flared up in the past,

region. Without stronger regional institutions,

but could now easily develop into full-scale wars

interdependence alone might not be a sufficient

with devastating social and political costs.

basis for peace and stability. Asia’s regional

Now a new type of conflict has come into the

institutions, such as ASEAN, have been reticent

fray: climate change, a global threat, is increasingly

in developing a role in dispute-settlement or

feared to become a “threat multiplier”, especially

conflict-resolution. Going forward, the key question

in the regions that are fragile and unstable to begin

is whether Asia can cooperatively manage its

with. In turn, this could lead to widespread famine,

conflicts without external help.

chaos and internal struggles, and conflicts among neighbors for energy resources. Several of Asia’s major rivers—the Indus,

So far, Asia has yet to seriously institutionalize such cooperation. Some foresee and advocate an Asian NATO, which, like the Atlantic institution itself,

Ganges, Mekong, Yangtze, and Yellow—originate

might help the region to deal with both traditional

in the Himalayas, If the massive snow/ice sheet in

as well as non-traditional threats. But according to

the Himalayas continues to melt, it will dramatically

some analysts the prospect for an Asian NATO is

reduce the water supply of much of Asia—and

unlikely to materialize for several strong reasons,

could lead to conflict.

ranging from a long-standing aversion, one might

A major challenge that Asia faces is whether

5 REALIZING THE ASIAN CENTURY: MEGA CHALLENGES AND RISKS

and tensions that characterize the relationships be-

even say a norm, against collective defense

it is going to develop the necessary mechanisms

arrangements, to the inability to articulate who or

to mitigate regional conflicts and manage

what exactly is the shared threat to Asia.

regional stability and order. At the moment, Asia’s

37

Realizing the Asian Century: A Strategic Framework 6 the world. Their much larger global footprint

This chapter presents a strategic framework and the contours of general strategies for Asia as a whole.

would require them to play a larger role in global

The framework covers three dimensions: national

governance.

action; regional cooperation; and collective action

t


Fourth, the diversification of export markets

on the global agenda. A brief discussion of the three

to reduce the current heavy reliance on North

dimensions is followed by an elaboration of the priority

American and European markets will require

actions within each of the dimensions.

Asian leaders to work together to remove behind-the-borders legal, administrative and logistical barriers against the free movement of

Three dimensions

goods and finance within the region. A distinguishing feature of Asia’s economic story

t


Fifth, managing some of the biggest risks facing

during the past fifty years has been the singular focus

the region—particularly, cross-country dis-

of most policy makers and political leaders on domes-

parities that could lead to conflict—will require

tic economic and social development. This was ap-

region-wide discussion and action.

propriate as countries attempted to eradicate poverty

t


The actions (or inactions) of the Asia-7 coun-

and rapidly catch up with the developed countries. It

tries will determine whether the less well-off

was also possible to do so when Asia’s global foot-

economies would share the benefits of the

print was smaller. But as the center of gravity of the

Asian Century—or be left behind.

world economy moves to Asia, culminating in its share

Given Asia’s diversity and widely varying country

of global GDP rising to half or more, it will no longer be

conditions, the precise actions and timing of measures

possible or desirable.

on the inter-generational issues must be country or

While the national policy agenda will always retain

subregion specific. They need to be formulated on a

its paramount importance, there are five reasons for

case-by-case basis. Even so, it is possible to articulate

Asian policy makers—particularly in the large Asian

an overall strategic framework and define the contours

economies—to look beyond their national borders.

of general strategies for the region as a whole.

t


First, many of the inter-generational issues discussed here have national, regional, and global dimensions.

t


The central dimension is strategic and policy ac-

Second, Asia has the most to gain or lose

tions at the national level. These range from getting

from the preservation of key global commons

the fundamentals of development right for the slow-

essential for future growth and prosperity: an

growth economies to sustained improvements in pro-

open global trading system, a sound and stable

ductivity and shifting comparative advantage to avoid

global financial system, a mitigation of climate

the Middle Income Trap for the converging economies,

change, and peace and security. It must play a

and to sustaining growth and moving from growth per

proactive role in any global discussions about

se to well-being in the high income economies.

them. t


The strategic framework covers three dimensions (Figure 1).

The second dimension is regional cooperation

Third, large Asian economies increasingly need

to pursue regional commons, maximize synergies

to take into account the potential impact of their

available from collaboration, and work toward shared

national policies and actions on the region and

regional prosperity. 39

“

Growth and inclusion need not be mutually

exclusive, but instead can be mutually reinforcing

6

Figure 1

Strategic framework

overall agenda. Asian policy makers must address these challenges in a coordinated manner to realize the promise of the Asian Century.

A STRATEGIC FRAMEWORK

Regional Cooperation

National action The focus of the proposed national economic and social policy agenda would differ significantly across the three country groupings. But, despite the national differences, it is possible to identify overarching issues

National Action

Global Agenda

and contours of general strategies for Asia: Growth plus inclusion Growth and inclusion need not be mutually exclusive, but instead can be mutually reinforcing. To sus-

The third dimension is the transformation in Asia’s interactions with the global community in line with its

a strategy to deal with inequality if it is to maintain the

expanding global footprint; this dimension will be reli-

social stability that has been so important for growth

ant on collaboration and collective action, particularly

until now.

among the large economies, to bridge the national and global agendas. Five criteria used for narrowing the list of issues

Asian countries must give much greater priority to inclusion and the elimination of inequalities—rural/ urban; educated/uneducated; along ethnic lines—

to address in this framework are: (i) the centrality to

throughout their societies. Asia will have to rethink its

the objectives of ensuring faster and more inclusive

policies towards distribution. Inequalities of oppor-

growth; (ii) avoiding the Middle Income Trap; (iii) the

tunity can no longer be disregarded, nor can islands

inter-generational nature of the issue and related solu-

of poverty (either in countries or groups in society)

tions; the horizontal inter-connectedness between

coexist easily with growing affluence. Rural develop-

them; (iv) the relevance to meeting the mega chal-

ment—including agriculture—will remain important in

lenges; and (v) the importance in light of Asia’s fast

all low and middle income economies. Urban inequity,

growing global footprint.

which has been rising in parts of Asia, will need to be

Many of the issues are interconnected and mutually reinforcing across the three dimensions. For

40

tain growth over the long-term, almost all Asia needs

addressed, and slums will need to be eliminated. The range of policy instruments is limited. A

example, financial transformation, the efficient use of

sharper focus on education and developing human

resources, and energy security, discussed below as

capital, with a particular focus on women, will be es-

part of national actions, are clear examples of issues

sential to fully realize the demographic dividend, and

that are important at all three levels. Similarly, urban-

is an obvious area, followed by government redistri-

ization, finance, energy efficiency and climate change

bution policies. Governments must also give priority

are closely interrelated at the national, regional and

to increasing access to quality infrastructure services

global levels. Each issue must be seen as part of the

as well as promoting innovation that meets, at an

“

Asia must adopt a new strategy and

approach to manage its coming rapid urbanization by promoting compact, energyefficient, green, slum free, safe and livable cities

affordable cost, the needs of those at the bottom of

financial centers and a number of truly global financial

the pyramid. Supportive environments for domestic

houses.

6

philanthropy can also play a significant mitigating role, Managing massive urbanization

as unemployment, disability, illness or death of a family wage earner. Minimum wage and active labor market

Between now and 2050, Asia will be transformed

policies, such as guaranteed employment schemes,

as its urban population doubles from 1.6 billion to 3.1

can make a difference but can also be abused. Mobil-

billion, truly staggering and truly historic.

ity of labor is important but that is best achieved when

A STRATEGIC FRAMEWORK

as can various forms of insurance against risks, such

Asia’s urban transformation can be an unparalleled

regulations ensuring migrant rights (domestic and

opportunity to increase productivity and improve the

international) are developed and respected.

quality of life of its citizens. Asia’s cities, expected to account for more than 80 percent of economic output,

Financial transformation

will be the centers of higher education, innovation and technological development. Urban buildings and

All else equal, as its share of global GDP rises to

transport will account for the bulk of energy consump-

50 percent or more, Asia should have about the same

tion and carbon emissions. Consequently, the quality

share of global financial assets and similarly-sized

and efficiency of urban centers will increasingly deter-

banking sectors, and equity and bond markets to ef-

mine Asia’s long-term competitiveness and social and

ficiently recycle and allocate Asia’s huge savings and

political stability.

foreign reserves. In growing and transforming their financial sys-

Asia must adopt a new strategy and approach to manage its coming rapid urbanization by promot-

tems, Asia must remain mindful of the lessons of the

ing compact, energy-efficient, green, slum free, safe

1997 Asian Financial Crisis and the Great Recession

and livable cities—more reliant on mass transit than

of 2007–09. Above all, Asia must avoid falling prey to

on cars. It must also manage some significant risks,

another bubble of excessively exuberant expectations.

particularly those associated with inequality, slums and

Asia will need to formulate its own financial model, avoiding both an overreliance on self-regulation by

a breakdown of social cohesion. Better financing and management of cities will

markets, as well as the current excessive central

require further decentralization of responsibility to local

government control of banking-dominated financial

governments, more local accountability and a move

systems present in many parts of Asia. It should

toward market financing of urban capital investments.

become more open to institutional innovation. There is

Urban development takes many decades. Timely ac-

also an urgent need to develop instruments and cre-

tion will require visionary leadership.

ate an enabling environment to finance Asia’s massive infrastructure and urban development needs through

Radical reduction in the intensity of energy and

public-private partnerships and public financial mar-

natural resource use

kets. In Northeast Asia, the special needs of ageing societies demand greater attention. National reforms must aim to create conditions to

The anticipated rapid rise in the living standards of some 3 billion Asians will put tremendous pressures

facilitate regional (and global) integration. Well before

on—and create intense competition—for Earth’s finite

2050, Asia should be home to one or more global

natural resources. 41

“

The recent deterioration in the quality

and credibility of national political and economic institutions (illustrated by the rise in corruption) is a key concern

6 A STRATEGIC FRAMEWORK

Based on current trends, Asia will surpass the

vergence” ladder. As more Asian countries emulate

OECD long before 2050 to become the largest energy

Japan, Singapore and Republic of Korea and come

consumer group. It will be most affected by, and most

closer to western best practice, this will not be ad-

responsible for, risks related to energy security and

equate.

climate change. To preserve its economic interest, it

In the future, the converging Asian economies and,

would need to take the lead in securing and de-car-

particularly PRC and India, must move from catch-up

bonizing energy through radical energy efficiency and

to frontier entrepreneurship and innovation and create

diversification programs. Action is needed in many

breakthroughs in science and technology, joining the

countries to eliminate energy subsidies and to switch

ranks of the high income economies. A particularly

from fossil fuels to renewables. There will be similar

fruitful area, where India has already demonstrated

issues for most other natural resources, including

notable successes, will be “frugal” innovation to meet

water and fertile land. The only way out is a combina-

the needs of millions of people with modest incomes.

tion of price increases (including the removal of any

The core requirement—where many Asian econo-

subsidies), more stringent standards (for buildings and

mies fall short—is quality education that promotes

transport), technological breakthroughs and adjust-

creativity at all levels, supported by an eco-system

ments in consumption patterns.

that fosters innovation and entrepreneurship.

Remedial actions will be needed at national,

The most critical element of the eco-system is an

regional and global levels. There is a strong synergy

overall policy framework that promotes competition

between energy efficiency and total factor productivity

and enables private sector development.

growth, which is needed for sustained convergence and global competitiveness.

Governance and institutional development

The key policy implication for all Asian countries is that their future competitiveness and well-being will

Asian economies across the three groups must

depend heavily on improving the efficiency of natural

improve governance and continually transform their

resource use and winning the global race to a low

institutions in order to meet the challenges of the com-

carbon future.

ing decades. The recent deterioration in the quality and credibil-

Entrepreneurship, innovation and

ity of national political and economic institutions (illus-

technological development

trated by the rise in corruption) is a key concern. High quality institutions will help the fast growing countries

The continuing rapid growth of Asian economies

countries establish the basic conditions for moving to-

full potential of technology, innovation and, critically,

ward sustained economic growth. Managing the com-

entrepreneurship.

mon challenges—be they rapid urbanization, building

The model in Asia, with a few exceptions, has

a fundamentally sound financial sector or fostering

been that of “catching up” with the more advanced

entrepreneurship and innovation—requires effective

economies and adapting the technologies developed

governance, both central and local.

there to produce for western markets. This was ap-

42

avoid the Middle Income Trap, and the slower growing

over the next 40 years will require harnessing the

Throughout Asia, an expanding middle class—

propriate when Asian countries were far from global

itself a desirable product of rapid socio-economic

best practice and on the lower rungs of the “con-

growth—will also exert new demands for increased

“

Avoiding the Middle Income Trap

must be the paramount objective of the fast growing middle income economies

voice and participation, transparent allocation of

vergers, and from middle income convergers to high

(budget) resources, accountability for results and

income or developed. While these overarching issues

enhanced personal space.

would be applicable to most Asian economies, their

critical for all countries to maintain social and political stability and retain the legitimacy of governments.

relative priority will vary by groups of countries and over time: 1.

Slow or modest growth in aspiring Asia.

As recent events in the Middle East amply illus-

The highest priority of this group of countries—

trate, the quality of communication between those

which accounts for the largest number of coun-

who govern and those who are governed will be

tries (though a small proportion of population)

paramount as new social media and other tools not

in Asia and includes both low and lower-middle

yet known—but certain to emerge—become available

income economies—must be to raise economic

to the public. Asia will need to dramatically improve

growth rates to approach those of their more

governance and its institutions with an emphasis on

successful Asian neighbors. Accordingly, these

transparency and accountability.

countries must focus on the fundamentals of

A STRATEGIC FRAMEWORK

Although daunting, the eradication of corruption is

6

development: promoting faster and more inclusive growth by reducing inequalities through

From growth to well-being

better education for all, infrastructure development and the development of institutions, and

As more Asian countries progress toward high

a business environment that promotes private

income status, they will need to adopt policies that

sector development.

promote broader social well-being and better lifestyle for individuals. Just as inclusion is critical to maintaining social co-

2.

Fast-growing converging economies. Avoiding the Middle Income Trap must be the

hesion and political stability in low and middle income

paramount objective of the fast growing middle

countries, a greater focus on well-being, personal

income economies, such as Armenia, PRC,

safety and happiness rather than more wealth, will

India, Indonesia, Kazakhstan and Viet Nam. In

be important with growing affluence. A shift in such a

addition to consolidating the fundamentals of

direction is critical in anticipation of the growing global

development addressed above, they should

competition for resources.

build credible and predictable institutions that

This requires a dialogue within Asia to understand

protect the property (physical and intellectual)

what that implies for the region’s growth model and

of investors and citizens alike and allow for fair

what can be done to improve well-being. And it may

dispute resolution. In addition, they will need a

be time to begin to define measures of well-being and

new vision in four crucial areas: (i) to manage

incorporate them in national surveys.

the challenges of rapid urbanization; (ii) to dramatically improve the efficiency of energy use

Priorities across country groups

and other natural resources (and thus delink their use from economic growth); (iii) to trans-

Over time, as countries develop and increase

form their financial systems to support develop-

their incomes and institutional capacities, they would

ment of the real sector while promoting stability

graduate from their current country category to the

and minimizing volatility in the markets; and (iv)

next one—for example, from non-convergers to con-

to promote innovation and entrepreneurship for 43

“

Regional cooperation and integration are

critical for Asia’s march towards prosperity

6

3.

enhanced productivity and competitiveness.

cooperation and collaboration will become significantly

A STRATEGIC FRAMEWORK

High income, developed economies. Coun-

more important for six reasons. First, cementing Asia’s

tries in this group—such as Japan, Republic of

hard-won economic gains in face of vulnerabilities of

Korea and Singapore—should lead the rest of

external shocks. Second, regional cooperation and

Asia in:

collaboration could be an important bridge between

t


t


t


moving from largely “catching up” with the

individual Asian countries and the rest of the world,

current global best practice in the United

and as a leverage for policy makers to implement

States or Europe to leading scientific and

domestic reforms that face strong headwinds from

technological breakthroughs in areas of

entrenched interest groups. To have its voice and influ-

special importance to Asia (e.g., biotech-

ence commensurate with its economic weight, Asian

nology; medical care for the aged; mitigat-

economies will need to coordinate, even harmonize,

ing climate change). In some of the green

their geopolitical positions on a range of global is-

technology areas, Japan and others are

sues. This can be done only through genuine and

already at global best practice level. This

regular regional dialogue and cooperation. Third, as

should become more the rule than the

Asian economies rebalance growth towards “internal”

exception.

(domestic and regional) demand, transport and energy

succeeding in sustaining high incomes

connectivity will pave the way for creation of a single

with an ageing society and a demographic

market. To sustain regionwide economic growth, they

deficit in the high income countries in

need to fully open their markets to neighbors in the

Northeast Asia. This unprecedented

region (in the same way the US and European markets

demographic reality will result in new

have been open to Asia since World War II). This

inter-generational expectations and rela-

will allow unhindered flow of trade and investments

tions and, in turn, will affect all aspects

(and more labor mobility, particularly of skilled labor)

of governance and require wide-ranging

throughout the 49 economies. Fourth, regional coop-

institutional adjustments, raising issues

eration and development assistance can help reduce

of fiscal affordability and sustainability. If

cross-country disparities in income and opportunities,

successful in meeting this challenge, these

which if left unchecked, could breed instability or even

countries could lead the way for others,

spark conflicts in parts of Asia. Fifth, collaboration

not only in Asia.

in technological development, energy security, and

formulating and implementing national

disaster preparedness can yield significant syner-

strategies to move beyond achieving high

gies and positive spillovers. And sixth, the skillful and

economic growth toward broader social

cooperative management of regional commons will

well–being. Japan’s efforts in this direction,

become increasingly important for Asia’s long-term

partly driven by demographic necessity,

stability, peace and harmony.

are relevant for the region and the world.

Avoiding conflict between mega-economies and nuclear states, and maintaining social and political

Regional cooperation

stability in the region will be paramount. Given its diversity, heterogeneity and, especially the lack of po-

Regional cooperation and integration are critical for Asia’s march towards prosperity. Greater regional 44

litical support in the major countries, Asia will need to develop its own unique model that builds on the past

“

Over time, Asia must gradually transform

its role to that of an active participant and a thought leader in formulating the rules on global commons issues

the world and has been heavily dependent on import

tom-up and pragmatic approach that facilitates free

of natural resources and commodities from other

regional trade and investment flows. This model could

regions, Asia’s long-term growth and prosperity are

build on the ASEAN experience and gradually include

intimately linked to an open world economy, robust in-

more economies over time, eventually resulting in the

ternational trading system, secure shipping routes and

unhindered flow of trade and investments, as well as

the international rule of law. Asia must sustain friendly

increasing labor mobility throughout Asia. The aim of

and business-like relations with countries nearby

these spontaneous actions and government initiatives

(Gulf countries, Russian Federation, Turkey, as well as

is to accomplish the creation of an Asian economic

Australia and New Zealand) as well as further away in

community. Such an approach will require stronger—

Africa and Latin America (in addition to maintaining its

though not necessarily new—regional institutions.

traditional close economic ties with North America and

The creation of an integrated and effective Asian

European Union).

economic community must be based on two gen-

In this context, Developing Asia’s stance on cli-

eral principles—openness and transparency. Asia’s

mate change and global warming requires a funda-

embrace of open regionalism implies that it does not

mental reassessment. Early and aggressive action on

discriminate against non-members while encourag-

climate change is demonstrably in Asia’s self-inter-

ing regional institutions to make the most of existing

est—socially, economically and politically. A change

global institutions and conventions. Meanwhile, trans-

in its current stance will also be a concrete and early

parency will enhance accountability and strengthen

demonstration to the world community that Asia is

governance.

willing and able to play a constructive role in preserv-

Crucial for increased regional cooperation is strong

ing the global commons.

political leadership. Given the region’s diversity, build-

As it becomes a larger player in the global econo-

ing Asia’s regionalism would require collective leader-

my, Asia’s self-interest and long-term prosperity will lie

ship that requires recognition of adequate balance

in ensuring well-being, peace and security throughout

of power among all participants. Major economic

the world.

powers, like PRC, Japan, Republic of Korea, India and

6 A STRATEGIC FRAMEWORK

positive experience in East Asia: a market-driven, bot-

Over time, Asia must gradually transform its role

Indonesia, will have an important role in integrating

to that of an active participant and a thought leader in

Asia and shaping its role in the global economy.

formulating the rules on global commons issues. The region as a whole must play a more proactive role in

Global agenda

global governance. Finally, the region must delicately “manage” its rap-

Asia’s growth and larger footprint in the global

idly rising role as a major player in global governance

economy will bring with it new challenges and respon-

in a peaceful and harmonious way. It will be important

sibilities which have significant implications for the

that as an emerging global leader, Asia act as—and

region, particularly for the large economies.

be seen as—a responsible and collaborative global

Asia must take greater ownership of the global commons, including an open global trading system,

citizen, non-threatening to others and fully cognizant of the global implications of its policies and actions.

stable global financial system, global climate change, peace and security. For example, as the region that has long prospered through trade with the rest of 45

Realizing the Asian Century: Inclusion and Equity 7 This chapter addresses a topic that is critical if the

inclusive growth relate to these concepts? Inclusive

fruits of Asia’s potential prosperity are to be shared

growth takes these concepts further by bringing in the

widely by all segments of its population. It starts by

concept of access and opportunities, but it is more

defining the concept of growth with inclusion and

closely related to the absolute definition of pro-poor

equity and then laying out the case for Asia’s lead-

growth than the relative definition.

ers to focus on it. Growth and equality are seen as

Under the absolute definition, growth is considered

part of a virtuous cycle. As noted in the brief review of

to be pro-poor as long as poor people benefit in ab-

Asia’s status in this respect, while the region has made

solute terms, as reflected in some agreed measure of

marked progress in reducing poverty, inequality and,

poverty.2 In contrast, in the relative definition, growth

particularly, non-income inequality, have remained high

is “pro-poor” if and only if the incomes of poor people

or have risen in a number of countries. This is most

grow faster than those of the population as a whole,

visible in the performance on Millennium Develop-

i.e., inequality declines. However, while absolute

ment Goals (MDGs) on indicators related to health and

pro-poor growth can be the result of direct income

sanitation. This gives rise to the term, “The two faces

redistribution schemes, for growth to be inclusive,

of Asia” (Box 2). The chapter also outlines the priorities

productivity must be improved and new employment

for Asian leaders to pursue this objective—by focus-

opportunities created. In short, inclusive growth is

ing on human development, redistribution policies and

about raising the pace of growth and enlarging the

social safety nets, and good governance.

size of the economy, while leveling the playing field for investment and increasing productive employment op-

What is inclusive growth?

portunities, as well as ensuring fair access to them. It allows every section of the society to participate in and

Inclusive growth refers to both the pace and pattern of growth, and encompasses aspects of equity,

contribute to the growth process equally irrespective of their circumstances.

equality of opportunity, and protection in market and employment transitions. Inclusive growth is both an

Why focus on inclusion and equity?

outcome and a process. On the one hand, it requires that everyone participate in the growth process, both

Although it may appear self-evident as to why a

in organizing the growth progression as well as in

focus on inclusion and equity is justified, it is useful to

participating in the growth itself. On the other hand, it

clarify the multi-faceted reasons for doing so, espe-

requires that everyone shares equitably in the benefits

cially when there may be trade-offs involved. In addi-

of growth. Therefore, inclusive growth implies par-

tion to ethical and moral considerations that lead to a

ticipation and benefit-sharing. Participation without

concern for equity, there are a number of pragmatic

benefit-sharing will make growth unjust and sharing

reasons for a focus on inclusion and equity. A number

benefits without participation will prevent it from being

of studies, most recently the Growth Commission’s

a desirable welfare outcome. In the past, discussion on the impact of growth on poverty and inequality has focused on concepts such as broad-based or pro-poor growth.1 How does 1 Tandon Ajay and Juzhong Zhuang, “Inclusiveness of Economic Growth in the

People’s Republic of China: What do population health outcomes tell us?” ADB Economic and Research Department Policy Brief, Manila: Asian Development Bank, 2007. 2 Ravallion, Martin and Shaohua Chen, “What Can New Survey Data Tell Us about Recent Changes in Distribution and Poverty?” Washington, DC: The World Bank Economic Review 11(2), pp. 357-382,1997..

47

“

Asia’s recent growth has resulted in a dramatic

decrease in poverty but income and, particularly non-income inequalities, have continued to rise

7

report3, have confirmed that growth strategies cannot

Finally, growth and equality should not be seen

INCLUSION AND EQUITY

succeed without a commitment to equality of opportu-

purely as tradeoffs, but as part of a virtuous cycle.

nity, giving everyone a fair chance to participate in the

More economic opportunities for the poor, when not

growth process and to enjoy the fruits of growth that

at the expense of other groups in society, can lead

follow.

to higher growth, which in turn can lead to further

The persistence of inequality could trigger social

opportunities.

and political tensions, and lead to conflict as is currently happening in parts of Asia. Rising inequalities

What is the status in Asia?

thus pose a risk to stability and, therefore, to growth and economic progress. In contrast to the strong correlation between

Asia’s recent growth has resulted in a dramatic decrease in poverty but income and, particularly

growth and changes in income measures of poverty,

non-income inequalities, have continued to rise. Many

Bourguignon et al. conclude that the correlation

Asian countries appear to have accepted significant

between growth and improvements in non-income

increases in within-country inequality as the price to

MDGs is practically nonexistent. This interesting

be paid for unleashing the forces of globalization. It

finding suggests that economic growth is not sufficient

is well understood that cities and coastal areas will

per se to generate progress in the non-income MDGs.

benefit first from globalization, while interior regions lag

Sectoral policies, including targeted interventions, and

behind. It is also accepted that owners of capital and

other factors or circumstances matter as much as

skilled workers will reap a disproportionate share of

growth.

the gains from globalization and that that can lead to

High levels of inequality can create institutions and cultures that favor those who have significant eco-

rising inequality in the short-term. Asia’s progress in poverty reduction has acceler-

nomic and political influence, perpetuating the cycle

ated in recent years. By some estimates, the number

of inequality. Equity can help give influence to a larger

of poor in East and South Asia was reduced by 425

group of people, which can shape institutions that will

million between 2005-20105. South Asia alone is

help the interests of more members of the economy.

expected to see a reduction of 430 million over 2005-

“Bad” inequalities are based on an individual’s circum-

2015, representing a fall in its poverty rate from 40

stances, as opposed to “good” inequalities that result

percent to under 9 percent.

from effort, and can lead to inequality traps. Chronic

This progress is not matched across other indica-

disparities in power, wealth, and status among differ-

tors as reflected in the review of Asia’s performance

ent socioeconomic groups are perpetuated by eco-

toward achieving the MDGs (see Box 1). Asia’s overall

nomic, political, and sociocultural mechanisms and

performance has been positive and has strongly

institutions.4 The capture of political power by an elite

influenced global progress. The region’s converging

that leads to political inequality aggravates the initial

countries have been leading in terms of addressing

inequality in endowments and opportunities.

the MDGs but all of Asia’s subregions are on track on more than half of the indicators. Nevertheless,

3 Kanbur, Ravi and Michael Spence, “Equity and Growth in a Globalizing World,“ Washington, DC: Commission on Growth and Development, 2010.. 4 Bourguignon, Francois; Francisco H. G Ferreira; and Michael Walton, “Equity, Efficiency and Inequality Traps: A Research Agenda,” Boston: Harvard University, 2006.

48

the region is lagging behind on some crucial targets, 5 Chandy and Gertz, “Poverty in Numbers: The changing state of global poverty from 2005 to 2015,” Washington, DC: Brookings Institute, 2011..

“

While there has been progress in education,

gender parity has not been achieved in most other areas. Women in the region experience some of the lowest rates of political representation, employment and property ownership in the world

Box 1

r


Between 1990 and 2008, the number of

r


Progress in basic sanitation has been

poor people living on less than $1.25/

particularly slow. The number of people

day, has been reduced from 1.5 billion to

without sanitation was 1.85 billion in 2008,

947 million, despite an overall population

almost the same level as in 1990. Asia is

increase of about 800 million people.

home to 70 percent of people worldwide

Gender parity in primary education has

who do not have access to basic

almost been achieved in most countries,

sanitation. r


though Pakistan and Afghanistan are

INCLUSION AND EQUITY

r


7

Asia and the Millennium Development Goals

While there has been improvement in

exceptions. Gender parity is on track at the

access to clean water, Asia is still home to

secondary level though it is slow in many

52 percent of the people worldwide who

places at the tertiary level.

lack such access.

Converging countries lead in terms of addressing the MDGs

100% 90% 80%

percent of MDG goals

70% 60% 50% 40% 30% 20% 10% 0%

Northeast Asia

Central Asia

Southeast Asia

Early Achievers

Slow

South Asia Regressing/No progress

Convergers

Non-convergers

Missing data

Source: ESCAP/ADB/UNDP, Paths to 2015, and Centennial estimates, 2011. High Income countries are excluded.

particularly those relating to childhood undernutrition,

ratio of the income of the top quintile to the income

health outcomes and sanitation.

of the bottom quintile, which ranges between 6 and

Inequality as measured by the Gini coefficient has been rising in a number of countries in Asia (Table 1). The relatively high, and in a few cases increasing,

9 in a number of countries, is yet another indicator of inequality. Also, while there has been progress in education, 49

“

Asia needs a strategy to deal with inequality

if it is to maintain the social stability that has been so important for growth until now

7

Table 1

Inequality is increasing in a number of Asian countries

INCLUSION AND EQUITY

Gini Coefficient Country Thailand

Initial Year

Change (%) Final Year

46.2

1992

42

2002

-9%

Malaysia

41.2

1993

40.3

2004

-2%

Mongolia

33.2

1995

32.8

2002

-1%

Indonesia

34.4

1993

34.3

2002

0%

Philippines

42.9

1994

44

2003

3%

Pakistan

30.3

1992

31.2

2004

3%

Viet Nam

34.9

1993

37.1

2004

6%

India

32.9

1993

36.2

2004

10%

PRC

40.7

1993

45.5

2004

12%

Lao PDR

30.4

1992

34.7

2002

14%

Sri Lanka

34.4

1995

40.2

2002

17%

Bangladesh

28.3

1991

34.1

2005

20%

Nepal

37.7

1995

47.3

2003

25%

Cambodia

31.8

1993

40.7

2004

28%

Source: World Bank World Development Indicators, 2011.

gender parity has not been achieved in most other

to maintain the social stability that has been so impor-

areas. Women in the region experience some of the

tant for growth until now. Inclusive growth as a de-

lowest rates of political representation, employment

velopment strategy is being embraced by many Asian

and property ownership in the world. Large differences

economies, multilateral agencies and civil societies.

exist between countries with the Philippines earning a very high score of 0.77 out of 0.85 (rank 9 out of

“Inclusive growth is the centerpiece of our devel-

134) on WEF’s Global Gender Gap Report (Figure 1),

opment agenda. Fast economic growth provides

followed closely by Sri Lanka, signaling that these the

us with the resources and the wherewithal to

countries demonstrate gender parity in most areas.

address the problems of poverty, ignorance and

On the other hand, India and Pakistan score 0.62

disease. Rapid growth will have little meaning,

(rank 112 of 134) and 0.55 (rank 132) respectively in

however, unless social and economic inequalities,

2010 with little improvement since 2006. High Income

which still afflict our society, are not eliminated

countries also score low with Singapore at 0.69 and

quickly and effectively.” (Manmohan Singh, 2010)

Japan at 0.65 (ranks 56 and 94 respectively), particularly due to low levels of female participation in the

“China is a strong supporter and follower of

labor force and political leadership.

inclusive growth, a concept that is consistent with

What is needed? Asia needs a strategy to deal with inequality if it is 50

our pursuit of scientific development and social harmony. While speeding up the transformation of economic growth pattern and maintaining stable

“

Asia will have to rethink its policies towards

distribution. Inequalities of opportunity can no longer be disregarded. Nor can islands of poverty (either in countries or groups in society) coexist easily with growing affluence

Figure 1

7

Asia’s economies rank low with regard to gender parity 0.85

1

0 9

0.8

20

41

0.75

40 51 57 61

score

0.7

60 72 82

0.65

84

87

88

80 89 94

97

98

99

100 104

0.6

rank (out of 134)

56

INCLUSION AND EQUITY

19

16

100 112

115 123

0.55

120 132

0.5

140

Score

Rank (out of 134)

Source: WEF Global Gender Gap Report, 2010.

and relatively fast economic growth, China is com-

prices, thought to be influenced by structural demand

mitted to integrating economic development with

factors as well supply shocks, will produce a sizeable

improvement of people’s lives.” (Hu Jintao, 2010)

terms of trade shift favoring rural areas over cities. As cities are the places that have benefited most from

Growth and equality may seem like mutually exclu-

globalization, this helps balance the distribution of

sive goals, yet they can be complementary. Develop-

gains throughout the economy. More resources going

ing economies tend to have significant market failures,

into rural areas will ease overall domestic inequality,

whether they are in credit markets, labor mobility, or

although it has the potential to widen both intra-urban

land ownership. Investment can be allocated inef-

and intra-rural inequality. The gains from higher food

ficiently due to these market failures, leaving potential

prices will disproportionately accrue to rich farmers at

economic growth on the table. Policies that encourage

the expense of landless laborers or subsistence farm-

investment towards those who would not have access

ers, and the urban poor.

to it otherwise can help to combat inequity and help

More generally, Asia will have to rethink its policies

investment to be allocated more efficiently, thereby

towards distribution. Inequalities of opportunity can

strengthening economic growth6.

no longer be disregarded. Nor can islands of poverty

At one level, global trends are favorable for combating inequity. The rise in food and other commodity

(either in countries or groups in society) coexist easily with growing affluence. The range of policy instruments is limited. Development of human capital is an

6 World Development Report 2006. Washington, DC: World Bank, 2006.

obvious area, as are government redistribution policies 51

“

policy makers must find an appropriate

balance between targeting the poor and policies that broadly improve the wellbeing of the majority of people

7

and good governance. A focus on human capital requires investment

social assistance and welfare schemes including conditional cash or in-kind transfers, and the provision of

INCLUSION AND EQUITY

in education, health, and other social/infrastructure

essential services for the most vulnerable groups; and

services such as water and sanitation. Merit-based,

(iv) children-related programs that also have a major

quality education that is equally accessible by all can

impact on developing human capabilities—protection

be one of the strongest drivers lifting people out of

to ensure the healthy and productive development of

poverty and toward greater equality. Access to clean

children. Worthy examples are early child development

water and sound sanitation, an area where Asia

programs, school feeding programs, scholarships, free

continues to lag, are not only a basic services but also

or subsidized health services for mothers and children,

vital for good health.

and family allowances or credit.

Government redistribution policies and social

Another example is vocational education and train-

safety nets could take the form of (i) labor market

ing (VET). There is an urgent need for Asian econo-

policies and programs aimed to contain unemploy-

mies to produce a workforce that can meet industry

ment and reduce employment-related risks; (ii) social

demands for skilled manpower to sustain competitive-

insurance programs such as pensions, health and

ness; and a VET system that is responsive to chang-

disability insurance, and unemployment insurance; (iii)

ing labor market conditions can play a crucial role. By

Box 2

Two faces of Asia

Developing Asia’s rapid growth disguises the rising inequalities. Rapid economic growth, rising population of rich along with the existence of

live with dignity—free of poverty and sharing in its prosperity. Developing Asia has to keep its foot on the

millions of poor who do not have access to basic

pedal to ensure not only that growth remains

education, water, sanitation and health services

buoyant and helps lift millions out of their daily

have given birth to what we say are the “two faces

suffering. It has to be inclusive so that benefits are

of Asia”—one that is witnessed in the glitzy towers

shared equally by all.

of Shanghai and Mumbai and the other seen in the

The task of meeting this challenge should

gloom covering the slums of Jakarta, Manila, and

not be underestimated. Even by conservative

Mumbai.

estimates, there would be millions of poor in

This growing economic dualism poses a threat

Asia by 2015 with incomes less than $2 a day,

to sustaining Asia’s dynamic growth and social

and millions who still do not have access to safe

cohesion.

drinking water, sanitation, basic education and

The “two faces of Asia” need to converge to sustain growth and maintain social harmony in the

health services. If we fail to address this challenge, the glitzy

region as well as within the countries. There can be

towers of Mumbai and Manila will continue to

only one Asia—one face of Asia, with opportunities

be surrounded by slums and threaten both the

open to all; an Asia where every individual can

economic progress and social cohesion of one of the most dynamic regions of the world.

52

“

Strong institutions and good governance

are fundamentally equitable and are needed to provide incentives for the vast majority of citizens to invent, be entrepreneurs, and to innovate

Figure 2

Large difference exist between sub-regions with regards to vocational education and training (VET)

7 INCLUSION AND EQUITY

Source: World Bank EdStats, 2011.

providing an opportunity to acquire skills for employ-

ate balance between targeting the poor and policies

ment, VET can also help the poor and disadvantaged,

that broadly improve the well-being of the majority of

and those who have dropped out of school and thus

people.

promote inclusion and equity The percentage of

Social and economic injustice that denies equal

secondary students enrolled in VET programs in Asia

opportunity based on individuals’ circumstances or

(13 percent) is low relative to Europe (24 percent) and

because they do not belong to certain power groups

particularly low in South Asia (Figure 2). While some

who control political and economic decision making

Asian countries have achieved gender parity in this

is often reflective of bad policies, weak governance

area, it remains a challenge in other countries.

mechanisms, faulty legal/institutional arrangements,

Considering the heterogeneity of needs, social

or market failures. In Developing Asia, factor market

safety net programs need to be ‘multilayered’ in

(land and credit) failures are particularly acute. The

their design. For instance, although conditional cash

central role of the government in promoting social

transfers can have an immediate impact on the poor if

and economic justice is to address all these market,

monitored effectively, they are at best a palliative mea-

institutional, and policy failures. Strong institutions and

sure; the longer-term solution lies with investments

good governance are fundamentally equitable and are

in skills development and promotion of sustainable

needed to provide incentives for the vast majority of

livelihood programs.

citizens to invent, be entrepreneurs, and to innovate.

Though many of the policies used to combat inequality target the poor, the middle class should not be neglected. The middle class is not only a driver of

They can best emerge when the distribution of power and influence is not highly unequal. The potential of the excluded groups is untapped

economic growth, but it also has substantial political

in large part because they lack access to a wide range

influence, so that policy makers must find an appropri-

of basic services—educational and health, as dis53

7

cussed above, but also financial services and security. Policies aimed at ensuring broad-based access to these services are likely to have a significant impact

INCLUSION AND EQUITY

not only on equality but also on growth. Some forms of inequality have long-gestational, multi-generational effects. These include issues of early childhood development, health, and access to quality education. They merit high priority and urgent attention.

54

Realizing the Asian Century: Financial Transformation 8 This chapter discusses the transformation of the

remind us that poorly managed finance can be highly

Asian financial systems necessary to underpin the

disruptive of trade, investment and growth. Long-term

advent of the Asian Century. It starts by outlining

projections of Asia through 2050 cannot rule out the

the likely growth of finance under the two scenarios

possibility of a “perfect storm” scenario, whereby the

portrayed in the report and makes the case for Asia

combination of bad macro-policies, exuberance com-

to move beyond the conventional financial wisdom

bined with lax financial sector supervision, conflicts,

and evolve its own financial model to better serve

natural disaster/climate change risks, demographic

the needs of the real sector. It outlines the nature of

changes and weak governance could lead to a major

financial transformation to build such a model. Next it

setback to Asian growth.

suggests priorities for regional cooperation. Finally, the

At the same time, the realization of the Asian Cen-

chapter discusses Asia’s global role, including in the

tury means that Asia should no longer be a price taker

governance of global monetary and financial systems.

or a rule taker. Increasingly it must become a price maker and rule maker in partnership with the other

Asia’s financial rise

major economies of the world. What is true of the real sector on a geopolitical basis should also be true

In 2009, Asia accounted for 27 percent of global

of the financial sector. But to be a globally respon-

GDP and 23 percent in global financial assets. By

sible citizen, Asia must also be a thought leader on all

2050, under the Asian Century scenario, Asia’s share

global commons.

of global GDP would almost double from 27 percent in

So far, Asia has been far less ideological and more

2010 to 51 percent at market exchange rates. Based

pragmatic in its approach towards the role of finance

upon current configurations of advanced country fi-

in economic development. This approach has served

nancial systems, Asia’s share of global financial assets

Asia well in the past decade, as illustrated by its re-

could rise to as much as 45 percent, with its financial

silience to the Great Recession. As a rising economic

deepening ratio (total financial assets excluding deriva-

power, with the highest levels of savings and holdings

tives as a percent of GDP) rising to 539 percent, com-

of financial assets, Asia can build a different finance

parable with levels in the EU and US. On the other

model by learning from the past financial crisis world-

hand, under the Middle Income Trap scenario, where

wide. This requires a radical change in the current

Asia’s share of global GDP remains only 32 percent

mindset.

as a number of Asian economies fail to break out of the Middle Income Trap, financial deepening would be

Conventional wisdom in finance

lower at 470 percent of GDP. In the scenarios, Asia will host some of the largest

The conventional wisdom of current economic and

global equity, debt and banking markets, with the

finance theory is based on assumptions of rational

region increasingly shaping the global financial archi-

expectations and efficient markets. The belief in unfet-

tecture, the monetary system and global financial in-

tered finance and free markets allowed global finance

termediation. Such scenarios are neither pre-ordained

to expand exponentially since the 1990s. However,

nor inevitable. Indeed, the Asian Financial Crisis of

financial regulation and risk management of deriva-

1997-98 and the Great Recession of 2007-2009

tives were seriously flawed, causing an unsustainable

(also often referred to as the Global Financial Crisis)

conundrum whereby finance was allowed to grow 55

“

The “free market knows best” dictum caused

complacency in financial oversight and surveillance

Asia’s global share of bonds, equities, and bank assets will rise

FINANCIAL TRANSFORMATION

60 50 40 30 20 10 0 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019 2021 2023 2025 2027 2029 2031 2033 2035 2037 2039 2041 2043 2045 2047 2049

Figure 1

Bonds, equies, and bank assets as (%) of world nancial assets

8

EU

United States

Asia

Source: Authors’ projections, 2011.

without limits, with its systemic risks underwritten by

must complement and support real sector activities.

the public sector. The unintended consequence was

Asia must move beyond its bank-dominated financial

unprecedented state intervention to stem the global

system and develop its capital markets to cushion the

financial crisis.

risks of the next phase of Asian development. Asia

The “free market knows best” dictum caused

should aim at becoming home to one or more global

complacency in financial oversight and surveillance.

financial centers and a number of global financial

The Independent Evaluation Office (IEO) of the IMF

houses.

has, for example, concluded that the IMF and the advanced countries paid little attention to the risks of contagion and spillovers, due to “a high degree of

Asia in the international financial architecture

groupthink, intellectual capture, a general mindset that a major financial crisis in large advanced economies was unlikely, and inadequate analytical approaches.” The current reform proposals already call for: greater state oversight; more stringent regulation, lower leverage and disincentives against excessive risktaking. As the world re-examines conventional wisdom and finance theory, the Asian approach should remain pragmatic based on the premise that finance should not grow at the expense of the real sector. Instead, it 56

Finance is global, and therefore national reforms are necessary, but they are not sufficient. Global financial stability cannot be discussed without a reexamination of the role of the global reserve currency and the shape of the global monetary and regulatory system. As the world moves from a single dominant economic power to a more representative multipolar environment, it is natural that there should be

“

Finance is global, and therefore

national reforms are necessary, but they are not sufficient

reserve currency issuers fail. The fourth path is direct

and financial architecture. As Asian finance becomes

or phased migration from status quo to a new Global

more sophisticated and larger in relative size, it will be

Reserve Currency System through re-negotiations

inevitable that leading Asian economies will sit at the

of the status quo. This is the set of proposals put

head table of negotiations over the future international

forward by the French Presidency of the G-20 in early

financial architecture.

2011. Whatever the outcomes, the new international

Having learnt the costly lessons in the 1990s,

monetary system should allow Asian economies to

the reserve build-up and subsequent liquidity sup-

play a leading role, either individually or through a

port arrangements (in the form of the Chiang Mai

platform such as the G-20.

8 FINANCIAL TRANSFORMATION

a more representative, multi-polar global monetary

Initiative and Asian Bond Fund Initiative based on the ASEAN+3 frameworks) offered a higher level of self-

Taming finance to serve the real sector

insurance against volatile capital flows and balance of payment deficits in Asia. But without reform of the

All financial systems have three important func-

global financial architecture, such self-insurance has

tions: (i) to efficiently allocate finance, (ii) to improve

high opportunity costs and spillover effects through

the payment system (by reducing transaction costs),

global imbalances.

and (iii) to manage risk (including transparency and

One of the root causes of the Great Recession was the flawed international financial architecture, cen-

corporate governance). For Asia to succeed, the Asian financial system

tered on the dominant role of a single national global

must evolve in ways that will perform the above func-

reserve currency. The cumulative current account

tions well while managing the major risks identified by

deficits arising from the Triffin Dilemma have resulted

the Great Recession, such as shadow banking, highly

in large global imbalances, including an unsustainable

toxic derivatives and the inequities and systemic exter-

US international balance sheet and large current ac-

nalities, and issues of moral hazard in modern finance.

count deficits.1 There are four possible paths to the future Global Reserve Currency System. The first is the status quo,

Broadly speaking, the key contours of the future sustainable Asian financial system should: t


Efficiently meet the resource allocation needs of

if Asia remains non-convergent, fragmented and

the real sector, particularly in providing credit,

subject to economic setbacks and internal conflict.

liquidity and payments functions, and risk

The second is a single dominant Asian currency that then contends for the dominant position in the Global

capital; t


Improve the price discovery process and trad-

Reserve Currency System. This has a low prob-

ing so that liquidity and transparent markets are

ability, because it would be quite difficult for a single

maintained;

Asian economy to achieve Asian dominance or global

t


dominance on its own. The third path is an intermediate Asian Monetary System before negotiating to join

Improve risk management, including insurance in the new volatile environment;

t


Enforce credit and financial discipline on all

the Global Reserve Currency System. This is likely

financial sector stakeholders by strengthening

to be a choice if negotiations with the current global

governance, self-restraint and preventing conflicts of interest with the real sector;

1 The Triffin Dilemma states that the reserve currency issuer has to run looser monetary policy (and by definition larger current account deficits) in order to meet global liquidity needs.

t


Protect long-term risk-adjusted real returns to pension and social security needs; and 57

“

Asia has a less developed financial

system with a larger role in the state in finance and economic life

8

t


long-term risk-adjusted positive returns, at

Be inclusive and responsive to all segments of

reasonable intermediation costs.

society, particularly those with less access to finance.

2.

Helping Asian investors—both private and

FINANCIAL TRANSFORMATION

institutional—diversify their portfolios outwards.

Asia has a less developed financial system with a larger role in the state in finance and economic life. To

Asian outward portfolio and direct investment

show leadership, Asian finance must provide risk capi-

will be the major capital outflow that the world

tal to serve the real sector without the state underwrit-

has not yet begun to appreciate. As PRC, India

ing huge losses.

and other middle income Asian economies begin to open up their capital accounts and

Transformational changes to serve the real

internationalize their currencies, global asset

sector

management portfolios will experience a quantitative and qualitative shake-up.

The transformation of Asian finance will be multi-

3.

Going back to basics with respect to their longterm ethical values by maintaining their fiduciary

faceted and extend over several decades to 2050.

responsibilities and trust in terms of customer Transforming business models for Asian

service and financial inclusiveness. In particular,

financial institutional structure

banks should reduce the “taxation” of depositors and investors through high net interest margins and fees.

The long-term real sector trends affected by demographic changes, urbanization, huge national

4.

and regional infrastructure needs, climate change

medium enterprises, as well as assist Asian

and changing industrial structure will reorient towards

corporations to merge, consolidate and re-

internal engines of growth. This suggests that finance

structure in response to a more globalized and

will need to change radically, as will the business

competitive Asia.

models for different financial sub-sectors. In the pe-

5.

become bipolar, comprising a few very large complex

6. 7.

web-based and mobile phone platforms, real-time monitoring of risks and microfinance. Local and foreign banks in Asia have to serve

Increasing risk management, regulatory quality and operational efficiency to global standards.

innovation will most likely come from direct customer services through phone or Internet banking, using

Improving payment systems and domestic operations to international standards.

banks with global span and a large number of smaller banks that serve their local communities. Financial

Meeting huge infrastructure and urban finance needs in Developing Asia.

riod to 2050, global retail and commercial banking will

8.

Through the localization and regionalization of financial innovation to customer needs.

To do the above and absorb the risks of higher real sector volatility, the capital adequacy ratios of

the following financial needs of a richer, urbanizing,

the banking system will be significantly higher than at

middle-class and also provide for an ageing Asian

present, probably in the order 10-15 percent of risk

population by:

assets, compared with the current levels of 7-8 per-

1.

Providing simple, convenient and trustworthy

cent. Financial regulation will be tighter, specifically to

consumer banking, with easy-to-understand

address the problems of systemic risk.

simple wealth management products that yield 58

Providing more finance and advice to small and

Asia needs to upgrade its banking-dominated

“

Asia needs to upgrade its banking-

dominated financial system and significantly deepen its capital markets

tive in the high-risk areas of finance, where high risks

markets to absorb the higher uncertainties of the

should be compensated by high rewards, without an

coming decades. Its commercial banks are large in

implicit or explicit public guarantees that create moral

quantity, but service quality and financial inclusiveness

hazard.

leave much to be desired. Its investment banking is still nascent and reliant on non-Asian players. The rea-

Asset management and capital markets

son is obvious—Asia’s financial sectors operate at the periphery of the center, because they are less open to

The asset management industry forms one of the

competition and there is insufficient deepening of fi-

core parts of the global capital market and has grown

nancial knowledge. Since financial systems in Asia are

rapidly in the last thirty years during a period of un-

still largely government-led, with varying degrees of

precedented financial innovation and deregulation.

financial repression, there is insufficient risk manage-

The dominant role of the advanced market’s share

ment and varying compliance with global standards.

in financial assets reflected partly their wealth and their

8 FINANCIAL TRANSFORMATION

financial system and significantly deepen its capital

ageing population, which require increases in their Investment banking and shadow banking

pension and retirement funds. For example, at the end of 2008, total retirement assets of US households

Currently, most Asian economies practice vari-

reached $13.9 trillion, roughly 100 percent of GDP.

ants of the repealed US Glass-Steagal legislation, the

Total global pension fund assets under management

separation of commercial banking from investment

were in the order of $21.6 trillion.2

banking. At the heart of the capital market debate is to

The rise of Asia and an emergent middle class has meant that the number of High Net Worth Individuals

what extent proprietary trading of financial institutions

(HNWI) is increasing very fast.3 The long-term pros-

should be supported by an implicit or explicit public

pects for the fund management industry in Asia are

guarantee of their financial stability? Asset trading

bright due to changing demographics and long-term

may be individually profitable; but in the long-run it is a

economic prospects for the emerging markets.

zero sum game, sustainable only if the real economy

But, Asia remains weak in its long-term wealth

generates new resources that support the rising debt

management. Its fund management, insurance and

burden. The point is that speculative trading initially

pension schemes lack institutional depth, they are

has a social value of providing liquidity and price

constrained by overly inward looking portfolios con-

discovery. But beyond a certain point, the accumula-

straints and some bound by capital controls. Despite

tion of speculative profits to the trading class changes

the high savings accrued from the high demographic

the incentives in the real economy away from pro-

endowment, Asia has yet to fully invest in Asia. Ac-

ductive investments into speculation and gambling,

cordingly, one of the top priorities within Asia is to de-

which ultimately fuels speculative bubbles that are

velop a strong asset management and pension fund

unsustainable by real sector productivity.

industry, by allowing greater private sector participa-

The challenge within Asia therefore is to separate the proprietary trading of investment banking and its

tion and liberalizing the portfolio restrictions on the pension fund industry by allowing more alternative and

advisory role from the funding guarantee safety net. It is to recognize that Asian governments should be more relaxed in allowing greater private sector initia-

2 McKinsey Global Institute estimates, New York: McKinsey, 2007. 3 Cap Gemini World Wealth Report, New York: Merrill Lynch, 2010.

59

“

the Great Recession has revealed serious

flaws in the assumption that commercial banking can solve all financial needs, particularly those of small and medium-sized enterprises (SMEs)

8

foreign investments.

knowledge-intensive of the financial sector, as its primary role is risk transformation. In order to cover

FINANCIAL TRANSFORMATION

Development finance and policy-

specific risks insured, the insurance sector must invest

based financial institutions

its premium income and generate a return and provide reserves that are sufficient to cover the payouts. The

The move towards market-based financial sys-

knowledge-based skills for the insurance industry,

tems in the last 30 years has meant that development

particularly its risk-management and actuarial exper-

finance institutions and policy-based finance have

tise, currently resides mostly in the advanced markets

largely lost their roles at the national level.

in the US and Europe. This needs to be changed.

However, the Great Recession has revealed serious flaws in the assumption that commercial banking

Radical transformation of the Asian insurance sector is required if it is to gain a larger market share.

can solve all financial needs, particularly those of small and medium-sized enterprises (SMEs). At the munici-

Exchange and clearing systems

pal and local government level, there is a shortage of funding for local infrastructure projects, which is not

Stock exchanges and clearing houses form the

met by the commercial debt market or the commercial

most important trading hub for equities trading. In

banks.

recent years, demutualization and the move towards

Given the need to develop specialist expertise in

markets with higher liquidity and quality have led to

high-knowledge intensive sectors, such as climate

more mergers or cross-holdings of stock exchanges

change, emerging market governments may need to

on a global basis. Stock exchanges are also con-

selectively revive and reform the roles of policy-based

solidating the trading of equity, warrants, financial

financial institutions in new directions.

derivatives and also commodities into single clearing platforms.

Insurance

The Great Recession has prompted financial regulators to rethink allowing financial derivatives to

Asia is grossly underinsured.

be completely traded over-the-counter (OTC) without

In life and non-life products, the potential for insur-

much transparency. There is now greater awareness

ance penetration in Asia is enormous. In 2008, gross

that some OTC activities are subject to fraud and mar-

insurance premiums accounted for 6 percent of GDP

ket manipulation. Hence, there is a movement to shift

in Asia and 3.6 percent in Africa, compared with 7.3

the trading of financial derivatives towards centralized

percent in America and 7.5 percent in Europe. In

clearing and on exchange to make the markets more

recent years, the growth of Islamic insurance has been

transparent.

at the rate of 25 percent per annum. Given the rising incidence of natural disasters from

ing mergers and upgrades of exchange and clearing

global warming, there is also considerable potential for

businesses, the latest being the Singapore Exchange

insurance and re-insurance for climate change-related

attempt to take over the Australian Stock Exchange.

risks. For example, in 2008, the total economic loss

The pooling of technology, trading processes and con-

from man-made and natural catastrophes around the

vergence of standards will improve the liquidity and

world was US$ 269 billion.

transparency of financial markets in Asia.

The insurance market is probably the most 60

Competition and consolidation in Asia are creat-

“

Asia’s financial sector will need to be

substantially reformed if Asia is to assume a leading role in the global financial system

Regional cooperation and Asia’s global

t


Liberalize and deepen risk management mechanisms and venture/hedge funds structures to

financial leadership

8

improve long-term returns to investors; t


Deepen long-term social security/pension fund

reformed if Asia is to assume a leading role in the

institutional capacity to deliver positive risk-

global financial system. Much of this will be at the

adjusted returns to investors over the long-term

national level, but quite a lot will depend upon regional

demographic cycle (as Asians begin to live

cooperation and dialogue with non-Asian partners.

longer, and retire earlier).

Individually, smaller Asian financial systems lack

Ensuring that policies are consistent with open

the critical mass of research, experience and skill

regionalization and global standards of openness,

levels to become leaders in finance. However, na-

transparency and fairness will entail the following

tional borders no longer bind knowledge and talent.

specific measures:

To achieve scale and leadership, Asia should confront

t


Open capital markets to greater private sec-

the issue of the lack of regional financial cooperation,

tor competition and participation, especially to

including currency arrangements.

regional and international competition. This will deepen financial innovation, and concurrently

Intra-regional trade in East Asia is now close to 56

raise institutional capacity.

percent yet intra-regional financial service trade is still constrained by regulatory and institutional barriers. It

t


Foster greater regional cooperation in finance in

is understandable that each Asian economy is wary of

terms of financial market infrastructure, espe-

allowing premature financial liberalization to weaken its

cially among the leading Asian markets in the

financial stability, but individually, many of the smaller

region beyond PRC and Japan.

markets lack the critical mass and scale to attain

t


board—involving banks, financial institutions,

From a macro perspective, the key initiatives for

insurance agencies, even central banks—the

regional financial reform should include the following: Reduce global imbalances to sustainable levels

problem posed by financial repression would

to allow market forces to work, more flexible ex-

abate.

change rate regimes and phased liberalization t


t


t


Create open regional networks in stock

of the capital account;

markets, debt markets and commodity and

Improve domestic financial sector efficiency

derivative markets that meet global standards in

through greater market competition and meet

terms of scale, transparency, efficiency and ro-

global regulatory standards;

bustness. This implies accelerating the process

Ensure that interest rates, exchange rates, tax

of allowing greater integration of regional stock

rates and regulatory costs/policies do not dis-

markets, clearing infrastructure and upgrading

tort long-term sustainable returns to depositors/

to international standards.

investors, consistent with risks; t


Improve risk management standards. With more standardization of operations across the

global competitiveness.

t


t


Adopt a multi-track approach to liberalize and

Deepening capital markets and managing “Too

to complete structural, institutional and gover-

Big to Fail” issues in banking and financial

nance reforms.

sector for long-term financial stability, including failed institution resolution mechanisms;

FINANCIAL TRANSFORMATION

Asia’s financial sector will need to be substantially

t


Open up the wealth management capacity to more private sector pension and social security 61

“

The time has come for the institutionalization

of Asian regional cooperation efforts, particularly in the area of financial safety nets

8 FINANCIAL TRANSFORMATION

t


t


fund management. Allow pension, insurance

The secretariat for the Initiative, ASEAN+3 Macroeco-

and long-term funds to invest in higher risk

nomic Research Office, can then act as the cluster of

financial products that yield long-term adjusted

research into policy options for Asian financial coop-

returns to long-term savers.

eration, complementing the regional surveillance and

Push insurance companies to improve their

cooperation roles of other fora, such as the Executive

risk management products in agriculture and

Meeting of the East Asia and Pacific Central Banks,

climate change/cyclical areas.

and other bodies.

Increase its voice in the international arena through regional subsets of the Financial

tionalization of regional cooperation efforts in building

Stability Board, central bank grouping within

long-term infrastructure funding frameworks, work-

the Bank for International Settlements and the

ing closely with the ADB to tackle sectoral issues of

International Organization of Securities Com-

demographic change, urbanization, municipal finance,

missions to ensure regional inputs into global

infrastructure needs, industrial restructuring and cli-

policy decisions as well as implementation and

mate change.

enforcement of global standards in Asia. The time has come for the institutionalization of

In summary, if the Asian Century scenario is to be realized, Asia would also need to become a global

Asian regional cooperation efforts, particularly in the

financial sector leader. Asia has the unique opportunity

area of financial safety nets. During the Asian Finan-

to radically build a more focused, leaner and respon-

cial Crisis, the advanced countries objected strongly

sible financial sector that serves its real sector objec-

to the creation of an Asian Monetary Fund (AMF).

tives. This means that the financial sector must first

With the creation of the European Financial Stability

and foremost discipline itself.

Fund, global objections to creating regional financial

None of these preconditions are inevitable or

safety nets (which can co-exist with the global finan-

pre-ordained. They can only be achieved with strong

cial safety net, IMF, at its apex) have been removed.4

political will and self-discipline. Above all, they require

In other words, it may be timely to consider expanding

Asians to work closely with each other and with the

the multi-lateralized Chiang Mai Initiative as a financial

rest of the world.

safety net that can co-exist with EFSF and the IMF.

4 Daniel Gros, “‘EMF in IMF’ instead of ‘EMF versus the IMF’” Brussels: Centre for European Policy Studies, 2010.

62

There is also considerable scope for the institu-

Realizing the Asian Century: A New Approach to Urbanization 9 This chapter suggests the need for a dramatically different approach to urbanization for Asia not only to

Table 1

Asia’s urban population will nearly double by 2050

cope with, but also to use the coming urbanization avalanche, as Asia’s urban population rises by 1.6 billion in the next 40 years. It highlights the vital role of

Asian Urbanization

2010

2050

Total Urban Population (millions)

1,649

3,247

mega and secondary cities for Asia’s economic com-

Northeast Asia

805

1,284

petitiveness as well as its social stability. It highlights

South Asia

496

1,261

the major risks most countries face. Finally, it points

Southeast Asia

252

520

out the massive management and leadership chal-

Central Asia

96

182

Urbanization (%)

41%

64%

Northeast Asia

50%

74%

South Asia

30%

55%

Southeast Asia

42%

65%

Central Asia

52%

67%

lenges, and suggests the priority agenda. Asia’s urbanization avalanche Asia is going through a historic demographic transformation from a rural society to an urban society

Source: UN World Urbanization Prospects, 2007 Revision.

that is far larger than any transformation seen in the past, in any other part of the globe (Figure 1). Approximately 44 million people are being added

urban areas are where the majority of Asia’s people will live, and where most of the GDP will be generated

to Asia’s urban population every year.1 By 2025, the

(it is approximately 84 percent of GDP today). They

majority of Asia’s population will be urban. By 2050

will be the centers of higher education, innovation

there will be some 3.2 billion urban inhabitants. This

and technological development. Finally, urban build-

represents an approximate doubling of the current

ings and transport will account for the bulk of energy

urban population of 1.6 billion people (Table 1). This

consumption and carbon emissions. As a result, the

rapid growth poses both enormous management

quality and efficiency of urban areas will increasingly

challenges and opportunities for city leaders.

determine Asia’s long-term competitiveness, as well

By 2050 even small, poor Asian countries will experience major changes. Cambodia’s urban

as its social and political stability. Asia must adopt a new strategy and approach to

population will grow from 20 percent to 44 percent,

manage the coming rapid urbanization by promoting

an increase of 7.5 million people. The Lao People’s

more compact, energy efficient, safer and livable cit-

Democratic Republic will grow from 33 percent to

ies. City and town planning, professional urban man-

68 percent, and add 5.2 million people to its urban

agement and self-financing will be important elements

population.

that will require much more attention. Some countries have already achieved levels of

Cities of the future

urbanization that the rest of Asia will achieve by 2050. The economic prosperity and high living standards

Asia’s urban transformation could be an unparal-

of Japan (67 percent urban), Republic of Korea (83

leled opportunity for increased productivity and an im-

percent urban) and Malaysia (72 percent urban), along

proved quality of life for all of Asia’s citizens. Cities and

with the economies of Hong Kong, China and Sin-

1 Asian Development Bank, “Managing Asian Cities,” Manila: ADB, 2008.

gapore, demonstrate the potential benefits of Asia’s 63

“

As Asia’s wealth and technological

prowess increases, it is possible to envision a few Asian cities that lead the world in technology, efficiency and quality of life

9

increases, it is possible to envision a few Asian cit-

future urbanization. Large urban mega regions will be the drivers of

ies that lead the world in technology, efficiency and

A NEW APPROACH TO URBANIZATION

Asian economies in 2050. Already, cities are grow-

quality of life. It is intriguing to consider what such an

ing together to form contiguous urban networks.

optimistic vision might entail; it is also certain that this

The mega region that runs from Seoul to Busan,

optimistic vision does not result from business-as-

for example, has around 46 million people and has

usual (Box 1).

been estimated to produce about $500 billion in local

Poor services and squalor are sadly all too com-

regional product. Some urban mega regions will be

mon in Asian urban areas today. More than half the

cross border regions where city-to-city ties are equal

world’s slum population currently resides in Asia—

in importance to nation-to-nation ties. The economic

some 490 million people in 2005, according to UN

relationships among the cities and towns that form

Habitat. This number is increasing despite the region’s

Asia’s urban mega regions will continue to expand

rapid economic growth. Many cities have unreliable

and deepen, fostering scale economies and economic

power supplies, intermittent water availability, insuf-

specialization. This will provide large economic gains

ficient treatment of wastewater before it is discharged

to jurisdictions that are able to manage the neces-

into local waterways, flooding due to poor drainage,

sary cooperative planning and operations of energy,

and uncollected garbage. Poor sanitation in low-in-

transportation, logistics and water systems, as well

come areas leads to poor health conditions. Poor sys-

as to successful business promotion, licensing, and

tems of land registration and the lack of tradable titles

marketing.

for large swaths of urban slum land create disincen-

As Asia’s wealth and technological prowess

tives to investment and renewal. Disputed land titles, the lack of a functioning land market in slum areas and

Figure 1

Northeast Asia will be the most urbanized region of Asia

unrealistic zoning are perhaps the greatest obstacles to improving slums in Asia. The OECD estimates that cities and towns currently account for between 60 to 80 percent of energy

80% 70%

consumption and global CO2 emissions. The pressure

60%

to reduce carbon use will only increase over time.

50%

Aggressive efforts are needed to improve the energy efficiency of buildings and appliances, to create utility

40%

systems that are based on reuse and recycling, and

30%

to manage land use and transportation systems that

20%

reduce costs and energy use.

10%

Compact, higher density cities like Singapore, Lon-

0%

don, Seoul, and Tokyo encourage a high percentage of walking and public transport trips, and have lower Northeast Asia

South Asia

Southeast Asia

Central Asia

Source: UN World Urbanization Prospects, 2007 Revision.

64

per capita CO2 emissions than lower density cities. However, urban densities in Asia are decreasing while middle class demand for automobiles is increasing rapidly. The growth in car ownership is increasing so

“

Compact, higher density cities like

Singapore, London, Seoul, and Tokyo encourage a high percentage of walking and public transport trips, and have lower per capita CO2 emissions than lower density cities

Box 1

9

Vision for a successful Asian city of 2050

sprawl is limited because prices, incentives

However, most people prefer the convenience and comfort of mass transit. Education, culture, the preservation of local

and infrastructure are designed to favor infill

heritage sites, parks, nearby eco-environments

development and compact patterns of city

and recreation opportunities are world class

expansion. Mass public transport is ubiquitous,

and seen as part of the city’s unique brand and

clean and efficient. Rail mass transit systems

competitive advantage.

predominate in the densest, richest countries;

The urban poor, defined as those below

bus rapid transit systems are the norm in

60 percent of the city’s median income, have

others. Many trips will be by walking in pleasant

access to quality health care and children’s

unpolluted surroundings. Energy efficiency

education. Unserviced slums disappeared after

is integrated into building design, appliances

a twenty-year campaign of upgrading—involving

and systems for lighting, heating, and cooling.

land titling, regularization, replanning, and the

Utilities for water, wastewater and solid waste

extension of basic infrastructure services. Some

rely heavily on reuse and recycling. Robots

of these areas still have housing units that do not

inside dwellings perform the household functions

conform to building codes but they are safe and

of laundry, cleaning, waste disposal and basic

affordable.

cooking; other household systems monitor the

A NEW APPROACH TO URBANIZATION

The successful Asian mega-city of 2050 has a density similar to Tokyo in 2010. Urban

City management is autonomous under

health status of residents, relieving the burden

a well-defined fiscal and administrative

of care of the elderly in ageing societies. New

decentralization framework that balances

private cars entering the fleet are zero emission

local responsibilities with local authority to

vehicles, running on electricity or hydrogen fuels.

raise resources. The local administration is

While great strides have been made in reducing

business friendly, striving to ensure that schools,

the carbon intensity of electricity generation,

universities and especially research universities

urban transport still accounts for 7 percent

continuously nurture creativity and innovation to

of carbon emission because of construction,

sustain high levels of productivity as technology

maintenance and fuel production. Cars

and business needs change rapidly. Close

communicate with each other and intelligent

cooperation exists with other cities and towns

traffic management systems anticipate traffic

that form the local urban mega region, including

flow and automatically route cars to the most

those across the national border. Infrastructure

efficient routes. Technology embedded in

and services are planned, implemented

highways and some streets take control of

and managed on a regional basis to ensure

vehicles to reduce congestion and accidents.

energy efficiency, productivity and a minimum ecological footprint.

65

“

Disparities in living conditions and

disparities in access to basic services are severe in many Asian cities. Social cohesion can break down when disparities get too high

9

fast that carbon emissions are expected to increase by 2.5 times over current levels in PRC and by 4 times

Figure 2

Urban Gini coefficient (by country)

in India by 2035, despite increased fuel efficiency. A NEW APPROACH TO URBANIZATION

Public transport is experiencing a significant loss of transport mode share. Lower densities are leading to sprawl, which is leading to higher rates of motorization, leading to more sprawl in a vicious cycle. In other parts of the developing world, a doubling of the urban population is expected to result in a tripling of urban-

0.5 0.45 0.4 0.35

ized land area. In Asia, the built up area is 6 times larger.2 Lower densities and sprawl will also mean much

0.3

higher costs to provide utilities and transport networks

With 84 percent of GDP currently eminating from towns and cities, the successful management of

Philippines

Nepal

Cambodia

Malaysia

Viet Nam

India

Mongolia

Bangladesh

Major risks to be managed

Pakistan

PRC

0.25 Indonesia

over a larger area.

Source: UN-HABITAT State of World Cities 2010/2011.

a national economy is intimately linked to the successful management of urbanization. The wave of demographic change that Asia faces will require an aggressive focus on city development by national and local authorities. Four risks stand out: (i) the growing

Figure 3

Urban Gini coefficients over time

inequality in cities; (ii) unmet expectations of the rapidly emerging middle class; (iii) the possibility of poorly

0.6

planned infrastructure and land use spiraling into high

0.5

quences of climate change and other natural risks. Inequality, growth of slums and breakdown of social cohesion Disparities in living conditions and disparities in

Gini Coecient

cost; and (iv) high carbon environments and conse-

0.4 0.3 0.2 0.1

access to basic services are severe in many Asian when disparities get too high. In PRC and India, urban

0 1969 1972 1975 1978 1981 1984 1987 1990 1993 1996 1999 2002

cities (Figure 2). Social cohesion can break down inequality has been trending upwards over the past

PRC 2 Angel, S., S. C. Sheppard, and D. L. Civco, “The Dynamics of Global Urban Expansion,” Washington, DC: World Bank, 2005.

66

India

Source: UN-HABITAT State of World Cities 2010/2011.

Malaysia

“

Talented people, the so-called knowledge

workers, are attracted by places where they can enjoy life. Cultural activities and amenities are increasingly central determinants of urban competitiveness

three decades (Figure 3). Most Asian cities have not yet faced severe problems of crime, drugs and violence. However, the

For towns and cities that are unable to manage the increased expectations for better services and better governance, the potential for instability will increase. Poorly planned infrastructure and land use

and high unemployment levels can lead to an explosive situation. Latin America presents a cautionary

Asia’s rapid urban growth is leading to lower

tale. Latin America’s wave of urbanization is roughly 65

density, unplanned sprawl as towns and cities react

years ahead of Asia’s urbanization. Argentina, Brazil,

both to the middle class’ demand for more space and

Mexico and Venezuela were unable to manage rapid

cars and to growing settlements of migrant workers. A

growth of illegal, unserviced settlements, and failed

small group of national and local governments in Asia

to provide adequate services. Slums and low-income

are already seeking ways to improve energy efficiency

urban peripheries are hotbeds of assault, aggres-

and reduce greenhouse gases. The Japanese govern-

sion, drug trafficking and violence of all kinds. In many

ment has introduced the concept of “Eco-Compact

cases urban gangs filled a gap left by underperforming

City” as a top priority for urban policy. Shanghai plans

local governments. Delayed action to improve living

to double the length of metro lines by 2020 in an

conditions for the poor in Asian cities could lead to

attempt to avoid automobile-driven commutes as its

Latin American style development—with zones of mo-

population becomes wealthier. Singapore has long

dernity co-existing with zones of misery and violence.

been an innovator in automobile demand manage-

A NEW APPROACH TO URBANIZATION

combination of rapidly growing cities, growing slum populations, disputed land tenure, corrupt officials,

9

ment. Higher-density, more compact cities are less Unmet expectations of expanding middle class

expensive on a per capita basis than are low-density cities. Higher density cities can also be exciting, enjoy-

The rapidly growing middle class in Asia is largely

able places to live, as exemplified by Tokyo, Hong

urban based. This group is better educated and

Kong, China, Singapore, Berlin, Paris, London, San

more in touch with global standards for services

Francisco, New York and others.

than cohorts in the past. They are seeking improved

While a few cities have adopted a formal vision for

infrastructure, services, modern shopping, cultural and

a sustainable future, most cities in Asia are moving in

recreational facilities and more green areas. Respond-

the wrong direction. They face the danger of being

ing to this demand can be part of a virtuous circle

locked into an irreversible, high cost, high energy land

leading to further growth. Most innovation, which is

use and infrastructure pattern.

the heart of a competitive global economy, occurs in urban centers. Talented people, the so-called knowl-

Environmental risks

edge workers, are attracted by places where they can enjoy life. Cultural activities and amenities are increas-

Many Asian cities face unpredictable risks from

ingly central determinants of urban competitiveness.

volcanoes, earthquakes, tornadoes, and the effects of

Urban areas that accommodate these new aspira-

climate change.

tions will have a better chance of succeeding and

The risks to cities from climate change are par-

innovating over the longer term. For Asia’s larger and

ticularly profound. These include severe water short-

medium sized cities this will be an important element

ages from a drier climate and reduced fresh water

to successfully shift from manufacturing to services.

flows from Himalayan glaciers, seawater intrusions 67

“

Many Asian cities still have a long

way to go in improving the functioning of their city administrations

9 A NEW APPROACH TO URBANIZATION

into aquifers, more severe weather patterns leading

prevent excessive borrowing, transparency processes

to possibly more intense typhoons, amplified storm

applicable to budgeting, accounting and procurement

surges, increased flooding of coastal mega-cities

systems and local government accountability via the

and increases in vector borne and diarrheal disease.

political process.

Among the more vulnerable larger cities are Kolkata, Mumbai, Dhaka, Guangzhou, Ho Chi Minh City,

New approaches to the finance

Shanghai, Manila, Bangkok, Yangon, and Hai Phong.

of urban infrastructure

Flooding risks are exacerbated by the subsidence from groundwater extraction: subsidence in Bangkok

Given the large capital investments that are re-

has been measured at 4 cm per year and in parts of

quired for urban infrastructure over the next 40 years,

Jakarta at 6 cm per year. It is estimated that a 30-year

recurrent revenues from local governments, national

storm event in Ho Chi Minh City by 2050, could affect

subsidies and ODA will not be sufficient. Much greater

12.5 million people and create 2 million

refugees.3

Planning and investing to mitigate these risks and

use should be made of land and property taxes to raise local revenues. It is imperative that national

improving collaboration and cooperation across coun-

officials engage in a serious partnership with local of-

tries in research, standards and approaches will yield

ficials to strengthen local financial capabilities and to

large payoffs.

provide a responsible framework for local government borrowing from private domestic banks and domestic

Priority agenda

capital markets. For revenue earning projects like toll ways and bridges, a formal system to establish public

Effective decentralization Past experience indicates that local knowledge,

private partnerships, PPPs, would be helpful. Competent city management

autonomy and accountability are needed to manage complex urban economies. Decentralization away from central governments to local governments is

improving the functioning of their city administra-

always difficult to implement, and can take decades

tions. Developing active working relationships with

until the details of the legal and regulatory measures

local private sector groups and civic bodies could

that guide local governments are fully implemented

make a start. A well-functioning city administration

and the skills and management systems needed for

needs professional staff that is given clear incentives

effective local governance are improved. Asia has

to perform at a high level. It needs institutions and

experienced significant decentralization over the past

policies to improve property rights, land registration

twenty years. This—so far uneven—process needs to

and titling, land use regulations, business registration

be accelerated and refined.

and permitting procedures, taxation and resource

Among the elements required for successful

mobilization policies, etc. The professionalization of

decentralization are local government access to own-

financial management is another key priority for cities

source revenues, clear prudential national rules to

and towns throughout Asia.

3 Risks identified in this paragraph are largely from Roland Fuchs, “Cities at Risk: Asia’s Coastal Cities in an Age of Climate Change,” Honolulu, Hawaii: East-West Center, 2010.

68

Many Asian cities still have a long way to go in

“

Asia needs city and national leaders that

are visionary...and who utilize the current wave of urban growth to implement that vision

Visionary leadership

9

Action needs to start at the very beginning of the investments only contribute to further distortions that will have to be undone later on. Asia needs city and national leaders that are visionary, leaders who can create new ideas for what modern cities should be and who utilize the current wave of urban growth to implement that vision.

A NEW APPROACH TO URBANIZATION

urbanization growth curve. Delays mean that today’s

69

Realizing the Asian Century: Reducing Energy Intensity and Ensuring Energy Security 10 Asia’s rapid growth has been accompanied by fast

international community. First, the growth in energy

rising energy consumption and carbon emissions. This

consumption implies an increasingly larger claim on

chapter addresses the need for many Asian econo-

global energy resources and higher dependence

mies to reduce energy intensity and manage energy

on imported energy triggering a concern about the

security concerns through programs to improve

security of energy supplies, particularly of oil and gas.

energy efficiency and diversification of energy sources.

Second, the growth in energy consumption is accom-

It concludes with a discussion of opportunities to gain

panied by a rapid increase in carbon emissions; the

synergy through regional cooperation.

International Energy Agency (IEA) has projected that by 2030, PRC alone will have higher carbon emissions

Rising energy consumption Asia accounted for about 20 percent of the world’s

than the OECD countries combined (Figure 2). Energy import dependency

energy consumption in 2000. This share jumped to 27 percent in 2007, and is expected to rise above 40

Concerns about energy, particularly oil, security

percent by 2050. PRC surpassed the US in 2010 to

in the Asia region are expected to heighten over the

become the largest energy consuming country, and

forthcoming decades. This is because of (i) further

Asia will surpass the OECD before 2030 to become

concentration of oil consumption in the transport sec-

the largest energy consuming block (Figure 1).

tor where the possibilities for fuel switching are limited;

The rapid growth in Asia’s energy use has created two major concerns for the region and within the Figure 1

Asia will lead world energy demand

(ii) an increase in import dependency, where Asia will become 90 percent dependent on imported oil by Figure 2

PRC and India will experience a significant increase in energyrelated carbon emissions

25,000

Mtoe

20,000 15,000 10,000 5,000 0 1980 1990 2000 2007 2030 2050 PRC

World

OECD

Non-OECD

Asia

Source: Author’s calculations, 2011.

Source: Author’s calculations, 2011.

71

“

Concerns about energy, particularly oil,

security in the Asia region are expected to heighten over the forthcoming decades

10

Table 1

Projection of energy demand and supply in Asia

REDUCING ENERGY INTENSITY AND ENSURING SECURITY

Asia Energy Demand (Mtoe)

1980

1990

2000

2007

2030

2050

1,625

2,220

2,910

4,242

7,980

11,480

PRC

603

872

1,105

1,970

3,637

5,011

India

207

318

457

622

1,341

2,389

ASEAN

149

243

389

513

903

1,177

Central Asia

95

198

128

159

256

385

46

120

185

373

565

557

629

746

896

995

1,112

Coal

40

42

47

48

50

Oil

16

17

20

21

20

Gas

9

10

11

12

11

Hydro

3

2

2

2

1

Biomass

26

24

15

10

7

Other (including nuclear)

6

5

5

7

11

2,249

3,057

6,113

17,267

26,181

Iran High Income Asia Asia Energy Supply Mix (%)

Asia electricity consumption (TWh) PRC

259

586

1,081

2,717

7,513

10,630

India

90

197

369

544

1,966

3,440

ASEAN

55

167

321

497

1,383

1,956

Central Asia

63

162

124

152

443

715

Iran

38

58

86

145

332

544

High Income Asia

831

976

1,012

1,128

1,411

1,746

World

7,228

8,761

10,018

12,013

16,790

22,288

OECD

4,050

4,476

5,249

5,496

5,811

6,011

Reference Energy Consumption (Mtoe)

US

1,802

1,913

2,280

2,337

2,396

2,412

Non-OECD

3,003

4,087

4,507

6,187

10,529

16,277

Source: EIA (2010), IEA (2008), IEA (2009), IEA (2010a), IEA (2010 b), World Bank (2010) and Author’s estimates, 2011.

2050; and (iii) a concentration of import sources. PRC, a net exporter of energy until the early

72

ports in 2006; gas imports are projected to reach 174 billion cubic meters (bcm) by 2050. India’s oil import

1990s, has now become a large importer of oil; the

volumes increased from 1.6 mb/d in 2000 to 2.5 mb/d

oil import volume of 4 million barrels per day (mb/d) in

in 2009 and are expected to reach 14 mb/d by 2050.

2009 is projected to reach 20 mb/d by 2050. Rapid

India would also need to increase its gas imports at a

growth in gas demand resulted in initiating LNG im-

rather rapid pace, particularly after 2020, to reach 140

“

Climate change concerns are changing the

policy mindset in most Asian countries with greater recognition of the significant synergy between that agenda and energy security

bcm by 2050. The ASEAN countries, once major exporters of oil

in: (i) the adoption of the advanced methods of energy efficiency; (ii) the push towards the development of renewable energy; and (iii) the openness to other

are likely to become net importers of gas in the next

sources1 with the recognition that the objectives of en-

three decades. The oil import requirement is expected

ergy security and the climate change agenda cannot

to reach 2.8 mb/d by 2030 and 5.4 mb/d by 2050

be achieved through energy efficiency.

while oil import dependency increases from 25 per-

Achieving energy security would also require a

cent in 2008 to 88 percent in 2050. Energy production

fresh set of policy measures that provide clear incen-

in Central Asia amounted to about 320 million tonnes

tives for unprecedented energy efficiency improve-

of oil equivalent (Mtoe) in 2007, half of which was ex-

ments, private investments and the adoption of

ported. The total oil production in the subregion was

advanced technologies.

2.5 mb/d and is expected to reach 5.4 mb/d in 2030,

For most Asian countries energy pricing is a

driven by an increase in Kazakhstan’s oil production.

sensitive but important issue. This is partly due to

Turkmenistan also has substantial gas resources, esti-

the prevailing energy subsidies and partly due to the

mated at 7.9 trillion cubic feet (tcf), to sustain exports

need to move to more advanced pricing regimes. For

in the long-term.

example, improving energy efficiency would require an

Globally, oil production is projected to increase

REDUCING ENERGY INTENSITY AND ENSURING SECURITY

and gas, have now become net importers of oil, and

10

aggressive time-of-day tariff design. At the same time

from 83 mb/d in 2008 to 105 mb/d in 2030 and 122

encouraging renewable energy development would

mb/d in 2050. Most of the projected increase comes

require various types of subsidies. It is important to

from the Organization of the Petroleum Exporting

keep these subsidies transparent, well targeted and

Countries (OPEC). Their total output rises from 36.3

confined to a limited timeframe. Desirable subsidies

mb/d in 2008 to 54 mb/d in 2030 and 73 mb/d in

include R&D support, feed-in tariffs, tax incentives and

2050. Oil production in non-OPEC countries is ex-

access to soft sources of finance. The predominant

pected to decline over the next two decades with only

instrument is the feed-in tariff, i.e., the price at which

Kazakhstan and Brazil likely to experience an increase

the utilities are obligated to buy the electricity gener-

in output. Similarly, global gas supplies will become

ated by renewable energy. This type of tariff should be

more concentrated in a small number of countries.

tailored to the type of renewable energy that is avail-

The Russian Federation’s gas supply is expected to

able in each country.

expand from 646 bcm in 2007 to 920 bcm in 2050, and that from the Middle East, from 357 bcm to about

Emerging energy technologies

1,250 bcm. Technology transfer has always been an embedded Priorities for domestic action

characteristic of energy sector development. However, the present circumstances are different in the

Energy efficiency and diversification

sense that technology is being developed on a fast track and is intended for rapid diffusion. There is a

Climate change concerns are changing the policy

strong momentum behind the “energy technology

mindset in most Asian countries with greater recognition of the significant synergy between that agenda and energy security. The shift is particularly noticeable

1 It is still too early to assess as to how the March 2011 nuclear incident in Japan would affect the future role and prospects of nuclear energy.

73

“

There is a strong momentum behind

the “energy technology revolution”

10

revolution” that stems from strict targets set by the EU

are expected to be significant producers in the future;

and other industrial countries to drastically cut their

large scale development is expected to require sub-

carbon emissions. The new targeted technologies are

stantial financial support for at least another 20 years.

REDUCING ENERGY INTENSITY AND ENSURING SECURITY

mostly proven but not fully commercialized. The most notable of these technologies are: (i) renewable energy including wind and solar technologies; and (ii) carbon

reduce carbon emissions to an acceptable level. On

capture and storage; and (iii) transport technologies

average, CCS is expected to add 3 to 4 cents/kWh to

including electric and plug-in hybrids vehicles, and

the cost of electricity generation in a new coal plant.

advanced bio-fuels.

World-wide, CCS capabilities are expected to emerge

Wind power technology is an example of a technology which has been successfully improved, and widely spread around the world. The cost of

after 2030, and reach a total capacity of 5 GT/year by 2050. The expansion of nuclear capacity faces seri-

wind power depends on site characteristics, but the

ous challenges. Though the technology is proven

average cost has declined from more than 20 cents a

there is a need to demonstrate the industry’s ability

kilowatt hour in the early 1990s to 6–7 cents a kilowatt

to build the latest nuclear plant designs to the most

hour today. Advances in wind power technology were

stringent safety standards on time and within budget.

initiated in Denmark when the country decided to de-

The earthquake-tsunami triggered nuclear incident of

velop a comparative advantage in this industry. Since

March 2011 in Japan is likely to require re-examination

then it has spread to many other industrial countries

of the nuclear energy development plans in various

like Germany, Spain, and the United States. Also very

countries of Asia and the world.

impressive progress has taken place in PRC, India and

The transport sector is currently an area of focus

Republic of Korea, where local firms have progressed

for new technologies due to its importance in climate

in a span of less than 10 years from no wind turbine

change and energy security. The most promising op-

manufacturing to state-of-the-art wind systems. In

tion for switching out of oil is the use of electric cars

2009 PRC overtook the US in having the largest wind

where electricity could be generated with alternative

power capacity.

energy sources. Improving transport technologies re-

Solar technology is at a much earlier stage with

quires an effective partnership between the public and

several new technologies under development. Most

private sectors. The IEA estimates that under such an

solar energy produced today is based on photovoltaic

effective partnership electric vehicle sales could reach

technology, which is expected to shift to thin-film tech-

100 million/year by 2050, accounting for about half of

nology and further developments resulting in the elec-

new light vehicle market. Within Asia, Japan and PRC

tricity generation cost of solar photovoltaic systems

are likely to play a pioneering role.

declining to around 5–7 cents a kilowatt hour by 2050.

In addition to helping with decarbonization and

A major promising technology is concentrated solar

thus mitigating climate change concerns, these new

power (CSP), which uses direct sunlight, concentrat-

technologies offer a major market opportunity for

ing it several times to reach higher energy densities

Asia. The global market for low-carbon technologies

and thus higher temperatures. It is expected to play a

in 2050 is estimated at over $3 trillion. A number of

major role in the decarbonization of the power sector,

Asian countries, including PRC and India, are well

and account for over 10 percent of worldwide elec-

positioned to gain a substantial share of this market.

tricity supply by 2050. Asian countries, such as India, 74

Carbon Capture and Storage will have a critical role in decarbonization as the fallback technology to

“

In addition to helping with decarbonization

and thus mitigating climate change concerns, these new technologies offer a major market opportunity for Asia

tant energy technologies including: (i) renewable

Public and private sector roles

energy such as wind and solar technologies; (ii) carbon capture and storage; and (iii) transport

A sustainable energy sector should rely on private

technologies particularly electric and plug-in

age the operation of various facilities, with the govern-

hybrid vehicles. Countries in the region can

ment taking charge of developing the energy diversifi-

benefit from the experience of Japan, a world

cation strategy and devising an incentive system that

leader in developing new energy technologies,

encourages all relevant players to serve the overall

the advances in Republic of Korea, and experi-

objective of improving the country’s energy security.

ences of PRC and India in indigenous R&D and adaptation of technologies.

There is a strong synergy between energy security t


Joint petroleum stockpiles have been consid-

new technologies such as wind and nuclear power

ered among some Asian countries but workable

are already economically viable based on a reasonable

agreements have not been achieved. Today,

price for carbon. Others require government support

almost every Asian country is in the process of

to move to large scale production which would result

reviewing its own emergency response mecha-

in a decline in the average cost of supply.

nism, and ASEAN+3 (Japan, PRC and Republic of Korea) has already started to discuss the

In either case, widespread diffusion of new technologies would require a government push and a

matter. It is recommended to launch an initiative

market pull, and close cooperation between the public

to support and expand the ongoing delibera-

and private sectors. Such cooperation would enable

tions to develop an Asia-wide energy emergen-

a more efficient transfer of technologies while utilizing

cy response system based on: (i) a long-term

the available sources of international support.

vision of the system; (ii) a transitional path to move from the present status to the ultimate

Finally, regulatory bodies have an important role in the proper functioning of the energy sector. Indepen-

model; (iii) mechanisms which are presently

dent and specialized regulators are needed to encour-

viable for a coordinated response; and (iv) an in-

age competitive market behavior. Regulators need

stitutional setup that could serve as a vehicle to

financial autonomy and clear authority to set tariffs.

implement short-term mechanisms and move towards the long-term vision.

At the same time, regulation has limits and should be confined to segments of the energy industry with significant economies of scale (natural monopolies).

REDUCING ENERGY INTENSITY AND ENSURING SECURITY

investors to build new supply capacities and to man-

and adoption of low-carbon energy options. Some

10

t


The integration of electricity and gas networks is the objective of numerous initiatives in Asia, and a regional energy market will be increasing-

Priorities for regional cooperation

ly appealing as Asia becomes the largest energy consuming region of the world. The ASEAN

Asia’s energy security agenda can be also sub-

approach of stepwise integration may provide a

stantially enhanced through regional cooperation and

good start for the region as a whole. While the

collaboration. There are at least three areas where

full integration of energy markets can only be

regional cooperation promises a win-win outcome for

considered as a long-term goal, it is feasible to

all the countries in Asia:

design an interim plan for the creation of sub-

t


Asia’s regional cooperation agenda should ad-

regional energy pools that are also harmonized

dress the transfer and sharing of several impor-

at the regional level. The process could include 75

“

Asia’s regional cooperation agenda

should address the transfer and sharing of several important energy technologies

10 REDUCING ENERGY INTENSITY AND ENSURING SECURITY

76

three distinct phases: Phase 1: expanding the

the long-term availability of energy resources. Building

bilateral trade (additional volumes, additional

strategic petroleum reserves and integrating gas and

numbers of countries); Phase 2: moving to a

electricity networks are an effective means of ad-

multi-lateral trade arrangement; and Phase 3:

dressing the first risk. The recommendations outlined

moving to a power-pool organization.

above for lowering energy intensity of the economy,

Regional cooperation in these areas would address Asia’s two distinct energy security risks: the sudden interruption of energy flows and the risks in

and diversification away from fossil fuels address the second.

Realizing the Asian Century: Action on Climate Change in Asia’s Self Interest 11 This chapter looks at climate change primarily

of 4.4oC above 1990 levels and 4.8oC above pre-

from the economic and social perspective of the

industrial levels. These temperature increases are

emerging markets economies. It is intended to pro-

associated with CO2 atmospheric concentration levels

vide a fresh perspective to Asian policy makers.

of more than 900 parts per million (ppm).

Specifically, the analysis looks at the economic self-interest of the emerging markets under three

Physical impact

scenarios: (i) a do nothing scenario—also called the business as usual approach—under which the

Temperature increases of 5oC represent danger-

current trends in climate change go unchecked for

ous climate change. Although the exact nature of

the next 40 years; (ii) a scenario under which the

the physical and social impacts in a world that is 5oC

developed countries listed in Annex 1 of the Kyoto

warmer is not known, it is commonly believed that the

Protocol take steps to reduce their emissions by 80

last time temperatures were this high—the Eocene

percent over 1995 levels by the end of 2050; and (iii)

period, 35-55 million years ago—swampy forests

a third scenario under which the major Asian emerg-

covered much of the world and there were alligators

ing market economies (plus Brazil and Mexico) take

near the North Pole.2

parallel actions to restrain their emissions by 2050 to

In such a world, the global water cycle would be

the same levels as their 2005 emissions (as proposed

significantly altered, with billions of people experienc-

by PRC in Copenhagen).

ing either very much reduced or very much increased

The chapter provides an overview of the likely temperature rises by

21001

under each scenario. It

water supply.3 The flow of rivers from the Himalayas, which serve a number of Asian countries that cur-

goes on to estimate the economic implications of

rently account for around half the world’s population,

each scenario on the emerging market economies

would likely be disrupted. Ocean acidity would signifi-

(including impact on agriculture production) in Asia,

cantly disrupt marine eco-systems and commercial

with specific references to the impact on the two larg-

fisheries worldwide.4

est developing countries, PRC and India. Economic impact Business as usual Developing Asian economies will suffer signifiThe business as usual scenario is based on the

cantly in this world. In this scenario, annual economic

historic relationship between GDP and emissions

damage in the Asia region would range between 3.1

for each country between 1990 and 2005, taking

and 10.6 percent of GDP in 2100. Agriculture is one

into account improvements in this relationship over

of the most sensitive economic sectors affected by

this period. The model uses forecasts for economic

climate change, and is an important sector in most

growth to 2050 under the Asian Century scenario.

Asian countries. It currently accounts for about 10

In this scenario, the world in 2100 will be substantially hotter with an average temperature increase

1 The report uses the year 2100 to be consistent with UN sponsored negotiations on a new global treaty on climate change that uses year 2100 as the benchmark year to estimate changes in average global temperature.

2 Stern, N. “The Economics of Climate Change”, Cambridge, UK: Cambridge University Press, 2007. 3 Warren R.et al, “Spotlighting the Impacts Functions in Integrated Assessment Models,” Norwich, UK: Tyndall Centre for Climate Change Research, 2006. 4 Royal Society, “Ocean acidification due to increasing atmospheric carbon dioxide,” London, UK: Royal Society, 2005.

77

“

Agriculture is one of the most sensitive

economic sectors affected by climate change, and is an important sector in most Asian countries

11

percent of their economy. Significant reductions in

by Tanser et al.6, which estimates changes in malaria

crop yields are expected in most countries in the

exposure in Africa by 2100. Results suggest that

business as usual scenario. Analysis from the World

under a no-mitigation business as usual scenario,

ACTION ON CLIMATE CHANGE IN ASIA’S SELF INTEREST

Bank and Muller et

al5

, shows that dangerous climate

change would lead to declining agricultural yields in

by 2100 parts of Africa would see a near five-fold increase in person-months of malaria exposure.

the vast majority of developing countries and that, in the case of India, Indonesia and Republic of Korea

Developed country action alone

the decline in yields would range between 14 percent and 20 percent. PRC is, on the other hand, expected

If only Annex 1 countries take action, global

to experience higher yields because of more favorable

warming will still be substantial. Even if Annex 1

climatic conditions.

countries reduce their emissions by 80 percent by 2050, the average global temperature in 2100 would still increase by 3.9oC above 1990 levels (4.3oC above

Sea-level rise

pre-industrial levels). This would be associated with A global temperature increase of

4.4oC

in turn

would lead to sea-level rises as high as 46 cm by

CO2 atmospheric concentrations of 780 ppm. A world that is 3.9ºC warmer still implies a radical

2100. This sea-level rise will threaten a large number

disruption to the physical and economic geography

of Asian cities. Measured by future populations that

of the earth. It is estimated there would be a 40-45

will be exposed to such sea-level rises, fifteen of the

percent decrease in annual water runoff in South

twenty most exposed cities (and nine out of the top

Africa and South America, and a 20 percent increase

10) are in Asia (Table 1). The exposed population in

in South Asia.7 The most affected regions of the

2070 is expected to be almost 95 million people. In

world would become too hot and dry to grow crops.

terms of asset exposure, thirteen of the twenty (and

It is estimated that 1.5 billion more people would be

eight out of the top ten) most exposed cities will be

exposed to dengue fever than a world with no climate

in Asia with a combined expected asset exposure of

change.8

$17.4 trillion. Climate change (and subsidence) will

Unsurprisingly, therefore, Asia would still experi-

increase the number of people exposed to coastal

ence hefty material economic losses. Aggregate

flooding in Bangladesh, India and PRC by 30 million.

losses for all of Asia would range between 2.6 and 8.1 percent of GDP in 2100. These losses are, of course,

Health impact

lower than in the business as usual scenario but— strikingly—only by a small amount. Relying exclusively

The health of Asia’s populations will suffer from

on action by the Annex 1 countries only reduces

such high temperature increases. Studies that estimate the future health impacts specific to Developing Asian countries are rare, but an example of the impact on developing countries in Africa is provided

5 Müller, C., A. Bondeau, A. Popp, K. Waha, and M. Fader, “Climate Change Impacts on Agricultural Yields”, Washington, DC: World Bank, 2009.

78

6 Tanser, F.C., Sharp, B. and le Sueur, D., “Potential effect of climate change on malaria transmission in Africa,” The Lancet 362(9398), pp.1792-1798, 2003. 7 Arnell, N.W., “Climate change and water resources in Avoiding dangerous climate change,” in Schellnhuber, H.J. (ed.), Cambridge, UK: Cambridge University Press, 2006. 8 Hales, S., de Wet, N., Maindonald, J., Woodward A., “Potential effect of population and climate changes on global distribution of dengue fever: an empirical model,” The Lancet, 360(9336), pp. 830:834, 2002.

Table 1

11

Asian cities feature prominently in the list of cities most exposed to half metre sea-level rises Exposed Population (2070) (000s)

City

Exposed assets (2070) ($bn, 2001)

Kolkata

14,014

Miami

3,513

Mumbai

11,418

Guangzhou

3,357

Dhaka

11,135

New York-Newark

2,147

Guangzhou

10,333

Kolkata

1,961

Ho Chi Minh City

9,216

Shanghai

1,771

Shanghai

5,451

Mumbai

1,698

Bangkok

5,138

Tianjin

1,231

Rangoon

4,965

Tokyo

1,207

Miami, USA

4,795

Hong Kong, China

1,163

Hai Phong

4,711

Bangkok

1,117

Alexandria, Egypt

4,375

Ningbo

1,073

Tianjin

3,790

New Orleans

1,013

Khulna

3,641

Osaka-Kobe

968

Ningbo

3,305

Amsterdam

843

Lagos, Nigeria

3,229

Rotterdam

825

Abidjan

3,110

Ho Chi Minh City

652

New York-Newark

2,931

Nagoya

623

Chittagong

2,866

Qingdao

602

Tokyo

2,521

Virginia Beach

582

Jakarta

2,248

Alexandria, Egypt

562

ACTION ON CLIMATE CHANGE IN ASIA’S SELF INTEREST

City

Source: Nicholls, R.J., Hanson, S., Herweijer, C., Patmore, N., Hallegatte, S., Jan Corfee-Morlot, Jean Chateau and Muir-Wood, R. ‘Ranking of the World’s Cities most Exposed to Coastal Flooding Now and in the Future, OECD Environment Working Paper No. 1, 2007.

Asian economic losses by 20 percent. With global temperature rises still substantial,

Complementary action by developing economies

potential losses from agricultural yields remain, and in the case of many Asian countries, the losses are

Only when the large Asian economies (plus Brazil

striking. India would still face a yield decline of over

and Mexico) act together with the Kyoto Protocol

10 percent, and Indonesia and Republic of Korea of

Annex 1 (developed) countries do they have the ability

more than 15 percent.

to have a meaningful impact on the outcome of the

Sea-levels would still rise substantially, continu-

global climate. Asian economies have a much greater

ing to threaten many coastal cities in Asia. Action by

incentive to act, since the damages they will suffer

Annex 1 countries is estimated to reduce sea-level

without action are notably the highest (see Figure 1).

rises in 2100 by only 5 centimeters (from 46 cm to 41 cm).

Consistent with their projected future high and growing emissions, Asia can make a marked difference to global temperature increases. In a situation 79

“

Only when the large Asian economies

(plus Brazil and Mexico) act together with the Kyoto Protocol Annex 1 (developed) countries do they have the ability to have a meaningful impact on the outcome of the global climate

11

Figure 1

Asia has both the ability and incentives to address climate change

are 50 per cent lower in 2050 than in 2005), then temperature increases are much reduced. Compared to the business as usual increase of

50000 45000

2050 emissions , Mt CO2e

ACTION ON CLIMATE CHANGE IN ASIA’S SELF INTEREST

4.4o

tries alone take action—the rise of global temperature

40000 Asia

35000

falls to 2.7oC (all on 1990 levels).

30000

The economic damages associated with these

25000

temperature increases in Developing Asia are signifi-

20000

G20 (excluding Asian countries)

cantly smaller, although they are still not negligible.

15000

Economic losses in 2100 fall to between 1.7 and 3.6

10000 Rest of the World

percent of GDP; at the high end, this is a reduction

5000 0

0%

C—and an increase of 3.9oC when Annex 1 coun-

1%

2%

3%

4%

5%

6%

7%

Damages in 2100 as a % of GDP

of more than 50 percent compared to the scenario where only Annex 1 countries take action. Figure

Note: Sphere size proportional to current population. Source: EMF Study by Vivid Economics based on RICE, 2010.

2 compares the losses faced by Developing Asia depending on the action taken. It clearly illustrates the importance of Asian action in diminishing the

in which action by Annex 1 countries to reduce emissions by 80 percent on 1990 levels is matched by a

economic damage they might face. The lower temperature increases that are an out-

commitment by the Asian developing countries to

come of Asian action are, for most Asian economies,

ensure that emissions in 2050 are no higher than they

expected to have a beneficial impact on agricultural

were in 2005 (and emissions from land use change

yields. In the case of India, Indonesia and Republic of Korea, the potential decline in agricultural yields is

Figure 2

Action by Asian countries can significantly mitigate damage from climate change

Without action by Asian countries, global temperatures

…Asia is expected to suffer annual damages of around

are expected to increase by 4°C, with a 10% probability

5% of GDP with a 10% chance they could higher than

that temperatures could be higher by 6°C or more

8%

8 7

6.7 6.0

6 5 4

3.5

3 2

2.6

2.3 1.6

1 0 Business as usual

Developed country Complementary Action + action by Developed Economies

High

Source: Author’s calculations, 2011.

80

Low

Median

2100 damages, % of 2100 GDP

Increase in temperature on 1990 leves expected by 2100, OC

and…

12

10.6

10 8.1

8 6 3.6

4 2

3.1

2.6

1.7

0 Business as Usual

Developed country action

Developed + emerging country action

“

the larger Asian economies—Japan,

Republic of Korea and, more recently, PRC and India—have already moved ahead in technological development and innovations necessary to promote green economies

expected to be cut back significantly—by more than 5 percentage points in the latter two countries. Sea-level rises are much lower in this scenario.

1

Progress in green technology

Over the last 2-3 years, many Asian countries have accelerated their action on climate change

ness as usual scenario—and which remain at 41cm

and clean energy. PRC, for instance, is now one

in the developed country case—increases are only 32

of the leading countries in the world in solar and

cm when Asian countries also take concerted action.

wind energy, electric cars, and even high-speed

In other words, while action by developed countries

rail technologies. It is the leading producer of solar

only generates a reduction in sea-level rises of less

photovoltaic cells, having dramatically gained

than 10 percent, if coupled with action by Developing

market share from the United States. In parallel, India has become a global player in wind energy and is developing an all electric car.

Accelerating the transition to low carbon

ACTION ON CLIMATE CHANGE IN ASIA’S SELF INTEREST

Compared to the sea-level rises of 46cm in the busi-

Asia, a reduction of more than 30 percent is possible.

11

economies form of a levy on coal producers, which is expected By making the low carbon transition, Asian coun-

to raise approximately $535 million annually.9 Overall,

tries will transform their economies towards a new

despite their reservations on a binding treaty at global

technological paradigm. This will bring greater energy

negotiations in Copenhagen and Cancun, the major

security, healthier and more productive citizens,

Asian economies—particularly Japan, Republic

cleaner cities, more productive agricultural sectors,

of Korea, PRC and India—are moving ahead with

and more efficient and competitive industrial sectors.

improvements on their own.

Fortunately, the larger Asian economies—Japan,

Asia has a strong incentive to accelerate the race

Republic of Korea and, more recently, PRC and

to a low carbon global economy: it has the most to

India—have already moved ahead in technological

lose from a slow transition, and the most to gain from

development and innovations necessary to promote

a fast transition. As discussed above, Asian countries

green economies (Box 1).

face very serious consequences if action to mitigate

During the Great Recession, a few Asian devel-

climate change is not quickly accelerated. Historically,

oping countries led the world in the percentage of

countries’ economic rankings have changed substan-

economic stimulus devoted to green measures. The

tially in response to technological progress in core

economic stimulus plans of Republic of Korea and

industries such as energy generation. Large Asian

PRC were judged to be 38 percent and 80 percent

economies already have a strong base from which to

green, respectively, (HSBC, 2009), significantly greater

seize the clean energy opportunities.

than the US or the EU. In November 2009, Republic

Waiting to take action will only increase the costs

of Korea pledged to reduce its emissions by four per-

especially if current investments are inconsistent with

cent below 2005 levels by 2020. In July 2010, it was

the requirements of a low carbon world and have to

reported that PRC will begin domestic carbon trading

be scrapped prematurely. Delays now will necessitate

programs during its twelfth Five-Year Plan (2011-2015)

steeper annual reductions later in order to reach the

to help it meet its target of reducing carbon intensity by 40-45 percent by 2020. Furthermore, in the same month, India imposed a “domestic carbon tax”, in the

9 Bloomberg Business Week, “India to raise $535 million from carbon tax on coal,” July 1st, 2010.

81

“

it is in the self-interest of Asia to act decisively

to mitigate climate change, and to do so urgently

11 ACTION ON CLIMATE CHANGE IN ASIA’S SELF INTEREST

same goal. For instance, if Developing Asian econo-

that they are willing and able to play a construc-

mies start taking action in 2012 to bring emissions

tive role in tackling this common global challenge.

back to 2005 levels by 2050, then they would have

They will be doing so even though some emerging

to achieve annual reductions in emissions of 0.4 per-

markets’ opinion makers believe that their economic

cent per annum. If they wait until 2030 before taking

growth may suffer somewhat over the short-term. It

action, with the intention of reaching the same target

is therefore important that the developed economies

by 2070, then average reductions of 1.5 percent per

participate in an equitable global burden sharing in

annum might be required.

both addressing the current stock of carbon emis-

It is clear that it is in the self-interest of Asia to act decisively to mitigate climate change, and to do so

future emissions at home as well as contributing

urgently.

technological and financial assistance to the less well off nations.

Global burden sharing By taking proactive and aggressive actions to mitigate climate change along the above lines, major Asian countries would also demonstrate concretely

82

sions contributed mainly by them, and in reducing

12

Realizing the Asian Century: Entrepreneurship, Innovation and Technological Development

Asia’s rapid growth has been based on, and must

create jobs. This point is brought to a sharp focus

be sustained through, continued improvements in

by the recent experience of socialist economies

total factor productivity (TFP). This chapter makes the

transitioning to market economies. In Viet Nam, dur-

case for Asian economies to promote entrepreneur-

ing the first seven years of reforms, net job creation

ship, innovation and technology development to

in the new private sector was 10 million, whereas job

ensure such improvements and their translation into

creation in the state sector was negative1. Second,

growth and well-being. The discussion is built around

entrepreneurs challenge the status quo by competing

the distinction between catch-up and frontier entre-

down the rents that accrue to the established incum-

preneurship. The chapter maps the Asian economies

bents—the famous claim of “creative destruction”

on this spectrum. Asia’s high income economies are

made by Joseph Schumpeter. This Schumpeterian

at the frontier end while most other economies are at

view of economic growth is relevant in any economic

the catch-up end of the spectrum. PRC and India are

context but particularly so in developing countries

in a special class with pockets of frontier innovation

where government protection and politically-sanc-

and entrepreneurship and the advantage of massive

tioned monopolies have a dominant market position.

scale co-existing with vast areas of catch-up entre-

The third mechanism is via innovations and techno-

preneurship. The chapter draws on the experience

logical progress. One economic analysis of important

within Asia and globally to derive lessons for the

innovations in the 20th century shows that 50 percent

converging and non-converging economies of Asia.

of innovations were generated by new and small

Specifically, the chapter outlines the elements of the

firms.2

eco-system that is required to enable and promote innovation and entrepreneurship.

We make a distinction between two types of entrepreneurship—catch-up entrepreneurship and frontier entrepreneurship. Catch-up entrepreneurship

Why focus on entrepreneurship

engages in replicative activities—activities invented

and innovation?

by others and replicated at competitive costs; its main economic contribution is job creation. Frontier

Robust entrepreneurial development based on

entrepreneurship is innovative and inventive, and

innovation and technological development will be

creates breakthroughs in science and technology.

central for all groups of economies in Asia in the

Frontier entrepreneurship is an important mechanism

next 40 years: (i) for the high income developed

to convert knowledge production into improvements

economies, it is the key mechanism to leverage their

for human welfare. This distinction is useful as a way

accumulated knowledge base; (ii) for the converging

to disaggregate the entrepreneurial landscape of

economies, fostering entrepreneurial development

emerging Asia.

is the most effective strategy to avoid the “middleincome trap;” and (iii) for the non-converging economies, entrepreneurship is the most efficient catch-up strategy to help them join the ranks of the converging economies. Entrepreneurship contributes to economic growth through several mechanisms. First, entrepreneurs

1 Johnson, Simon H., McMillan, John and Woodruff, Christopher M., “Property Rights and Finance,” Cambridge, Mass: NBER, 2002. 2 Acs, Z. J.- Audretsch, D. B., “Innovation in Large Firms: An Empirical Analysis”, American Economic Review, 78(4), pp. 678-690, 1988.

83

“

The sustained growth of Asian economies

must be anchored in improvements in total factor productivity (TFP)

12

Entrepreneurship and innovation in Asia

Technology), as well as its science towns.3 Republic of Korea faces constraints similar to Japan arising

The sustained growth of Asian economies must ENTREPRENEURSHIP, INNOVATION AND TECHNOLOGICAL DEVELOPMENT

be anchored in improvements in total factor productivity (TFP). A mapping across the dimensions

from hierarchical limitations and seniority control in large Korean companies. The continental economies, PRC and India, are in

of TFP levels (2007) and TFP growth (1985-2007)

a class by themselves not just because of their size

highlights the position of the different Asian econo-

but because of the heterogeneity of their economic

mies (Figure 1) on the productivity landscape. The

structures and the depth of their scientific and tech-

high income developed economies such as Japan,

nological know-how. They have vast areas where

Republic of Korea, Taipei,China, Hong Kong, China

catch-up entrepreneurship holds the key for growth

and Singapore are leaders with regards to TFP levels.

and employment but also deep pockets of innovation

These are the frontier economies where entrepre-

clusters that contribute toward global scientific and

neurship and innovation are concerned.

technological leadership. The scale effect is an impor-

Japan has slowed moderately in terms of TFP

tant source of demand and a source of supply of

growth. Most innovations in Japan are aimed at

talent and capabilities that enable innovation. Milton

saving energy, raw materials, time and space to

Friedman famously asserted, “The conquest of the

enhance global competitiveness. Thus, the central

technological frontier, like the conquest of the geo-

feature of innovation in Japan is continuous improve-

graphical frontier, requires millions of individuals.” The

ment. Innovation happens mainly in larger “corporate

scale effect may explain why capital flocks to PRC

groups” rather than in small companies in a corporate

and India. In the rankings by the Boston Consulting

culture that encourages incremental innovation; radi-

Group of “100 BCG New Global Challengers,” 38 of

cal innovation is less common.

the challengers operate in PRC and 19 in India com-

Singapore looks the most impressive when

pared to the Russian Federation (6 firms) and Brazil

considering both TFP levels and growth rates. This

(14 firms) . Fortune 500 companies have 98 R&D

reflects an impressive commitment to scientific

facilities in PRC and 63 in India.

research, especially in life sciences. The Singaporean

Other converging economies such as Indonesia,

government has funded and promoted scientific

Malaysia, Thailand and Viet Nam are closer to the

research with the goal of becoming “the Boston of the

catch-up end of the entrepreneurship and techno-

East”. It pays great attention to developing its educa-

logical innovation spectrum. These countries have

tional system with a specific focus on attracting world

experienced moderate TFP growth but have been

class education institutions to Singapore.

constrained by a number of factors. Malaysia’s

Since the early 1980s, Republic of Korea has

entrepreneurship and technological innovation is

gradually transformed itself from being an imitator

constrained by two major obstacles: education and

to becoming an innovator, based on rapid growth

training, and government regulation.4 Malaysia, like

in R&D expenditures, and greatly supported by its

many others, lacks an effective financial system to

top universities, (Seoul National University and the

support entrepreneurship. Thailand, Indonesia, and

Republic of Korea Advanced Institute of Science and 3 Alif Farhoomand, “Innovation in Asia with Patent Data,” Hong Kong, China: Asian Case Research Center, 2005. 4 “Malaysia Firm Competitiveness, Investment Climate, and Growth,” Washington, DC: World Bank, 2005

84

“

The converging economies in Asia, and

even more so the slow growing economies, generally do not have the systems, institutions and policy practices that promote and nurture frontier entrepreneurship

12

Total factor productivity: levels and growth rate, 1985-2007

1 120

ENTREPRENEURSHIP, INNOVATION AND TECHNOLOGICAL DEVELOPMENT

Singapore

Brunei Darussalam 100

USA Hong Kong, China 80

TFP 2007, US =100

Germany

Taipei,China

Japan Republic of Korea 60

Malaysia 40

Iran Azerbaijan Tonga 20

Georgia

Kiriba

Kazakhstan Samoa

Solomon Islands

Thailand Fiji Turkmenistan Sri Lanka Philippines Vanuatu Pakistan Bhutan Indonesia Federated States of Micronesia India Uzbekistan Papua New Guinea Cambodia Marshall Isl.Lao PDR Mongolia Viet Nam Tajikistan Kyrgyz Rep. Bangladesh Nepal

PRC

0 -3

-2

-1

0

1

2

3

4

5

annual % change in TFP, 1985-2007 Source: Centennial calculations, 2011.

Viet Nam share similar problems, such as inadequate

The converging economies in Asia, and even

infrastructure and access to finance, an inadequately

more so the slow growing economies, generally do

educated workforce, a relatively poor work ethic in

not have the systems, institutions and policy practices

the national labor force, an ineffective government

that promote and nurture frontier entrepreneurship.

bureaucracy, and policy instability.

This problem has not deterred Asia from rapid growth

Particularly interesting are the impressive TFP

with a largely replicative model so far. It may, however,

growth rates of a significant number of countries in

very well turn out to be the stumbling block for the

Central Asia (Figure 1). Azerbaijan and Kazakhstan

converging economies in their efforts to maintain their

stand out, possibly making up for the significant

growth momentum and avoid the Middle Income

losses in GDP and productivity following the collapse

Trap.

of the Soviet Union, and benefitting from increases in energy production and transit. Most disappointing

Major lessons

is the low TFP growth performance of the nonconverging countries.

There are four major lessons that emerge from our 85

“

countries need to think of the enabling

environment for entrepreneurship—particularly as they move towards frontier entrepreneurship—in terms of a complex multi-faceted eco-system

12

analysis of entrepreneurship in Asia and globally. First, entrepreneurship and technological develop-

faceted eco-system. The following section draws on

ENTREPRENEURSHIP, INNOVATION AND TECHNOLOGICAL DEVELOPMENT

ment are heavily sequential: countries move from

examples in Asia—particularly PRC and India —to

catch-up entrepreneurship to frontier entrepreneur-

outline the key elements of such an eco-system.

ship, rather than directly leapfrog into the latter phase.

These include: human capital development through

Knowledge production is a cumulative process rather

quality education at all levels; a commitment to sci-

than, as often portrayed in the media and policy

ence, technology and R&D; the rule of law with an

discussions, one of leapfrogging. PRC and India

effective regime for intellectual property rights as well

first succeeded in catch-up entrepreneurship and

as for exit/bankruptcy; the availability of financing for

subsequently added frontier entrepreneurship to their

entry and the subsequent phases of entrepreneurial

development toolkits. In Asia, the country that has

activity; and, critically, an overall policy framework that

been most successful—in terms of both the outcome

is based on competition and rewards innovation.

and speed of this transition—is probably Republic of Korea (Box 1). Second, successes in frontier entrepreneur-

Key elements of the entrepreneurship and innovation eco-system

ship have an extraordinarily long gestation period. Governments must think ahead and commit them-

Not surprisingly, education lies at the core of the

selves to a long-term, well-planned policy course. The

entrepreneurship and innovation eco-system. Many

seeds for several innovation success stories out of

countries in Asia fare poorly on this front; this is ironic

PRC and India were in fact planted decades before

given the high value that many Asia societies place

their economic and commercial successes mani-

on education. It is also disturbing because education

fested themselves—in the early 1970s, for the Indian

shows the strongest correlation with entrepreneurship

pharmaceutical industry, and in the mid-1980s, in the

and TFP. While the coverage of basic education has

case of the Chinese green technology sector (Box 2).

improved and is reasonable throughout the region,

Third, there is a role for second-best interventions

enrollment at the secondary level falls off sharply.

in the short-run. PRC and India, while quite suc-

Enrollment at the tertiary level, with a few exceptions,

cessful in nurturing entrepreneurship and achieving

is remarkably low. Unfortunately, the quality of educa-

some breakthroughs in innovation, still suffer from

tion remains a major concern at all levels. Higher

gaps in the policy and institutional environment for

quality must accompany higher enrollment rates if

entrepreneurship and innovation. In the short run, it

Asian economies are to competitive in the future.

is probably only realistic to take institutional condi-

Asia’s high income, converging, and non-converg-

tions as given and devise policy interventions that

ing economies have very different enrollment rates

substitute for shortfalls. One example of such a policy

that are very much in line with their positions with

intervention is targeted financing and administrative

regards to TFP growth. High income countries have

intervention by the Chinese government to expand

high levels of secondary and moderate levels (above

the research capabilities of its universities and to fos-

60 percent) of tertiary education. There is a sharp

ter linkages between universities and industry.

fall-off in the enrollment rates in converging econo-

The final lesson is that countries need to think of the enabling environment for entrepreneurship—particularly as they move towards frontier 86

entrepreneurship—in terms of a complex multi-

mies, particularly at the tertiary level as highlighted by PRC (21 percent) and India (only 12 percent).

“

Not surprisingly, education lies at the core of

the entrepreneurship and innovation eco-system

Box 1

12

Republic of Korea’s transformation into a center of science and technology

capacity to improve on it, the country shifted to the development of indigenous R&D in the 1980s.

to frontier entrepreneurship and has exemplified a

The government’s outward looking development

significant leadership commitment to technology

strategy has encouraged investments in long-

and innovation-based economic development.

term risky projects, many of which have turned

In 1960, the country was among the poorest

into impressive success stories. Gross R&D

in the world, with a GDP of $24 billion and with

expenditures (GERD) are among the highest in

unemployment rates at 22.3 percent. Today,

the world at 3.21 percent of GDP in 2007, an

Republic of Korea is one of the world’s most

impressive increase from 0.77 percent in 1980.

modern industrial economies with a GDP of $986 billion and an unemployment rate of just 4 percent. The country has few natural resources and is

In response to the Asian Financial Crisis of the late 1990s, Republic of Korea increased public R&D budgets and, through an overhaul of

heavily dependent on imports for energy and raw

existing regulations and tax credits, created an

materials. This reality, together, with a longstanding

environment that would promote the development

sociocultural eagerness for education, has pushed

of a technology-based SME sector and encourages

it to invest in human capital and in science and

venture start ups. As a result, TFP levels have risen

technology development.

exponentially and, in PPP terms, Republic of Korea

Republic of Korea’s government catalyzed technology development in the country by initiating

ENTREPRENEURSHIP, INNOVATION AND TECHNOLOGICAL DEVELOPMENT

Republic of Korea is a prime example of a country that has made the transition from catch-up

this year will bridge the gap with Japan which stood at 30 percent in 1990.

significant R&D spending, in some instances at government institutes set up for this purpose. In 1980, the government had a share of 64 percent of R&D expenditures and government institutes performed 62 percent of R&D. Over time, the private sector has taken on the lion’s share of R&D spending, and now accounts for 75 percent of expenditure and about 90 percent of R&D performance.

Republic of Korea: Selected indicators

1990

Latest

GDP (MER)

$414 billion

$986 billion

GERD (% of GDP)

2.42 (1996)

3.21

37

98

290

12,508

100.5 (1995)

221.9

Tertiary enrolment (% gross) US-registered patents Number of researchers (millions)

Beginning in the 1960s and 70s, with a focus on technology transfers as a means of technology

Source: IMF WEO, October 2010; UNESCO Institute for Statistics, 2011; World Bank Edstats database, 2011; National Science Foundation Science and Engineering Indicators, 2010.

acquisition and the development of domestic

Non-converging economies lag even further behind

startup businesses established by the Massachusetts

(Figure 2).

Institute of Technology (MIT) graduates, faculty and

Universities are probably the most important

MIT itself shows that as of 2006 the sales value of

producer of the kind of knowledge that leads to

these businesses came to $11 trillion, roughly equal to

transformative product innovations. One study of

the size of Republic of Korea’s GDP. 87

“

Higher quality must accompany

higher enrollment rates if Asian economies are to competitive in the future

12

Box 2

From catch-up to frontier innovation

ENTREPRENEURSHIP, INNOVATION AND TECHNOLOGICAL DEVELOPMENT

By one objective measure, India today has

A comparable example from PRC is in the area

one of the most competitive pharmaceutical

of green technology. PRC’s substantial progress

industries in the world. On the most recent

in the field of green technology is often portrayed

WHO pre-qualification list there are 137 drugs

as “leapfrogging.” In fact, PRC’s substantial gains

manufactured in India, compared with only five

result from a long process of accumulating and

manufactured in PRC. Indian firms, such as

absorbing knowledge from prior practices. The

Ranbaxy and Biocon, have increasingly moved to

plan to invest heavily in green-tech was approved

acquire an R&D profile, and are no longer limited to

very early, in 1986, by Deng Xiaoping himself,

manufacturing existing drugs. These achievements

according to one account. PRC’s success in this

did not happen overnight. The turning point for

field also heavily leverages its manufacturing

India’s pharmaceutical manufacturing came with

prowess. For example, one of the most successful

the 1970 Patent Act which shortened patent

Chinese firms in solar panels, Wuxi Suntech, relies

protection under the Patents and Design Act of

on core technology from Australia but was able to

1911 from 16 years down to 3-5 years. The Act,

rapidly scale up production because PRC has a

together with a foreign exchange control act and

well-developed supply chain. Similarly PRC’s gains

price controls, is generally credited with the birth

in wind turbine technology, gasification equipment

of India’s indigenous pharmaceutical industry.

and grid construction can be attributed to its scale

India’s transition from catch-up entrepreneurship

and experience in equipment manufacturing.

to frontier entrepreneurship in the pharmaceutical

In other words the strength of PRC’s catch-up

industry was marked by a milestone 35 years

entrepreneurship provided the foundation for the

later—the 2005 Patent Act that lengthened patent

transition to frontier entrepreneurship.

protection to 20 years.

Asia’s high income economies are home to a

of world-class institutes. The close collaboration

number of world class institutions. Of the converg-

between universities and industry that is required for

ing economies, PRC has made dramatic progress

successful innovation and entrepreneurship is rare in

in recent years. University facilities have also been

most economies in Asia, as compared to the experi-

upgraded; teaching and experimental equipment

ence in the US.

has doubled in the past five

years.5

Moreover, post-

The nature of education is also significant.

graduate enrollment in PRC has now surpassed

Entrepreneurship and innovation can only flour-

levels in India, growing more than five-fold, from

ish in an eco-system that fosters creativity, and

70,000 in 1998 to 365,000 in 2006, of which doctoral

tolerates risks, failures and out-of-the-box thinking

enrollment is

208,000.6

India has a small number

and behavior—broad capabilities that are best addressed through a country’s educational system.

5 Ministry of Education. “Education and Training Industry Report 2006” Beijing; Ministry of Education, 2006. 6 “PRC’s colleges to enroll 5 percent more students in 2007,” Beijing, PRC: Xinhua News Agency, January 24, 2007.

88

The systems in many Asian countries (including India and PRC), however, have come under severe criticism for their emphasis on rote memorization and

“

Entrepreneurship and innovation can

only flourish in an eco-system that fosters creativity, and tolerates risks, failures and out-of-the-box thinking and behavior— broad capabilities that are best addressed through a country’s educational system

Figure 2

12

Much of Asia lags in secondary and tertiary enrollment

100

20

School enrollment, terary

40

School enrollment, secondary

60 School enrollment, primary

percent of gross

80

0

North America

Asia average

High income

Convergers Non-convergers

Central

Northeast

Southeast

South

Asia

Source: World Bank Edstats database, 2011.

test-taking—leading to what is increasingly recognized also by Asian leaders as a creativity deficit. Frontier entrepreneurship and innovation are sci-

An intangible, far harder-to-quantify element of the eco-system is the level of the political commitment to science and technology. One measure of

ence-based, and R&D is a useful metric of a country’s

this commitment is the level of officials in charge

commitment to science and technology. Asia now

of science programs in PRC. In 1986, for example,

accounts for about one-third of the world’s spending

PRC plans to invest in alternative energy projects

on R&D. It has recently surpassed Europe, and is

was approved personally by Deng Xiaoping; the

soon expected to surpass the US. As a percent of

“National Basic Research Program” (initiated in the

GDP, Japan and Republic of Korea rank particularly

1980s) which focuses on basic research in “strategic”

high with expenditures of 3.4 percent and 3 percent

industries was said to have been personally endorsed

of GDP, respectively. PRC’s R&D spending rose from

by Zhu Rongji, PRC’s vice premier in charge of the

0.6 percent in 1996 to a likely 2 percent in 2010 (a

economy (later the premier from 1991 to 2002), who

level more common among developed countries), and

also chaired the National Steering Group for Science,

is planned to reach 2.5 percent of GDP in 2020.

Technology and Education. Asia also offers a number

Absolutes and scale—and not just the percent

of other examples of significant leadership and sus-

of GDP—matter with R&D spending. In 2006, PRC

tained policy commitment such as Republic of Korea

spent $136 billion on R&D, overtaking the $130 billion

and Singapore.

spent by Japan and reaching about 40 percent of the

ENTREPRENEURSHIP, INNOVATION AND TECHNOLOGICAL DEVELOPMENT

120

Another critical element of the eco-system is

United State’s spending levels ($330 billion in 2006).

the availability of financing for the different phases

India invests a relatively low 0.8 percent of GDP in

of the entrepreneurial cycle, particularly early stage

R&D.

financing in order to get past the current excessive 89

“

Foreign direct investment has a spillover

effect that has provided the seed financial and human capital as well as technology to domestic entrepreneurial ventures

12 ENTREPRENEURSHIP, INNOVATION AND TECHNOLOGICAL DEVELOPMENT

dependency on public sector financing. India started

the depoliticization of the research funding process,

its financial reforms in the early 1990s, simultaneously

an arms-length relationship between government

with its broad economic reforms, with an emphasis

and research institutions, and the spirit of free inquiry.

on the market-based pricing of IPO issuances, the

Many Asian countries currently put too much of a

gradual privatization of Indian banks, and improve-

premium on government controls and planning, and

ments in the corporate governance of listed firms

less on individual actions and initiative. A challenge,

on Indian stock markets, etc. The net result is that

unique to PRC, is whether truly transformative innova-

India’s financial system, though not yet fully adequate

tions can occur under institutional and political condi-

to finance innovation, is more broadly supportive of

tions that put a high premium on controls rather than

private sector development as compared with the

on discussion and debate.

PRC financial system. Linked to financing is the need for well-regulated bankruptcy/exit mechanisms. Foreign direct investment has a spillover effect

Finally, the business environment is a vital element of such an eco-system. The rule of law is relevant not just for entrepreneurship but for economic activity

that has provided the seed financial and human capi-

more broadly. The intellectual property rights regime

tal as well as technology to domestic entrepreneurial

gains much greater importance as economies move

ventures, particularly in PRC and India, creating

from catch-up entrepreneurship towards frontier

conditions for innovation. For example, GE-India (with

entrepreneurship. There are also the commonly

3,500 researchers) has focused on developing India-

cited elements of doing business: ease of starting a

specific technologies and applications. Microsoft’s

business, of registering property, getting credit and

R&D center in Beijing now files the second largest

enforcing a contract. With the marked exception of

number of patents within the Microsoft system (sec-

the high income economies, Asia has a long way to

ond only to its headquarters in Seattle).

go in this regard (see Figure 3).

Not surprisingly, the overall policy framework is

The situation with respect to physical and tech-

of great importance. PRC and India have followed

nological infrastructure, another important element of

different paths in this respect. Many of the innovations

the eco-system, is similar. The most critical elements

in India have come from the corporate private sector

have to do with competition and the enabling environ-

and are market-based, as opposed to being driven by

ment for broad-based private sector development.

government-funded programs to increase the supply

Entrepreneurship and innovation on a large scale

base of knowledge. The demand-side dynamics have

in Asia can best be promoted by the “consolida-

been crucial to India’s innovation successes. Indian

tion of competitive capitalism with the dynamism of

firms have led the rest of the world in developing

large and small businesses depending on innovation

the cheapest cars (Tata’s Nano is priced at $2,500),

rather than influence”.7 In many Asian economies,

cheapest mobile phones (at $20), cheapest phone

there are tendencies toward oligarchic capitalism

call rates, cheapest cataract surgery (at $30), and

based on state capture (as also witnessed in Latin

the cheapest laptop (at $35). These pioneering

America) which must be checked through appropriate

achievements have so far not been matched by

competition policies, effective regulatory structures,

PRC firms, which, paradoxically, appear not to have

procedures to check corruption and influence, a

internalized the powerful logic to cater to the bottom of pyramid. A general eco-system that is conducive to innovations has certain generic features, such as 90

7 Walton, Michael, “Tackling Structural Inequities,” in India 2039: An Affluent Society in One Generation, Kohli and Sood (eds), Washington, DC: Sage, 2010.

“

Another essential element to promote

entrepreneurship is an openness to competition and a business environment which facilitates entry and entrepreneurship on a large scale

12

Asian countries’ rankings in ease of doing business vary by region and income/convergence level

Non-convergers

Convergers

High Income

South Asia (excl. India)

Central Asia

PRC

Southeast Asia

Northeast Asia (excl. PRC)

Lan America & Caribbean

Asia

Europe

Asia

0 20

5.2 16.7

17.2

rank (out of 183)

40 42.5 60 80

55.1

56.4 75.0

79.0 87.3

100 101.5 120

106.8 121.4

140

134.0

160

ENTREPRENEURSHIP, INNOVATION AND TECHNOLOGICAL DEVELOPMENT

North America

World regions

India

Figure 3

Source: World Bank Doing Business, 2011.

broad-based and inclusive financial system, trans-

Some of the elements of the innovation and entre-

parency and accountability, and an independent

preneurship eco-system illustrated above are more

judiciary.

relevant for the converging economies since they are requirements for frontier entrepreneurship, which

Priorities

is much more demanding of the eco-system than catch-up entrepreneurship. At the same time, many of

Entrepreneurship and innovation are vital to economic growth and that they have to be explicitly fostered, cultivated and given ample space for

the underlying measures have long gestation periods and would thus benefit from early attention. Most Asian economies need to make significant

development rather than being taken for granted.

investments in human capital development by ensur-

For the non-converging Asian economies, catch-up

ing both, higher enrollment rates and higher quality

entrepreneurship and innovation is vitally important

at all levels of education. Improved learning with an

and likely to remain the most relevant strategy for

emphasis on creativity can help foster higher pro-

some years. For these countries, the policy priority is

ductivity, innovation and entrepreneurship. Another

not high-tech development but to get the economic

essential element to promote entrepreneurship is an

and business environment fundamentals right. The

openness to competition and a business environment

mistake that policy makers in Asia must avoid is to

which facilitates entry and entrepreneurship on a

create a policy and regulatory environment to favor

large scale.

frontier entrepreneurship at the expense of catch-up entrepreneurship. 91

Realizing the Asian Century: Transforming Governance and Institutions 13 This chapter discusses the greatest challenge

horizon, a good basis to discuss the broad direction

Asia faces in its endeavours to realize the Asian

of Asia. The broad range of issues covered and their

Century: transforming governance and institutions.1

multi-faceted dimensions require that one should

The chapter presents an analytic framework to

look for a broad number of indicators in measuring

assess the current state of governance and institu-

governance. A solid basis to discuss Asia’s direction

tions and the changes therein over time. It compares

starts with an analysis of the multi-faceted dimensions

various governance indicators of Asian economies

of governance and institutions—even if there are

with other emerging countries and outlines the key

obvious uncertainties associated with a 40 year time

drivers for change (demographics, urbanization,

horizon. The conceptual complexities require that we

expanding middle class, and the communications

use different indicators to measure the transformation

revolution). Finally, it identifies key actions of institu-

of institutions.

tional change and discusses principles and priorities for transforming governance throughout Asia.

Table 1 provides a framework to identify entry points to stimulate governance and institutional changes, together with related principles. The

Analytic framework

framework combined with the drivers for governance changes (see further below) point to the likely

It is essential for all Asian countries—across the

directions for Asia over the next decades. However,

three groups—to focus on improving governance and

Asian policy makers cannot rely on “international best

transforming institutions in order to meet the chal-

practice” but rather have to look for the “best fit” for

lenges of the coming decades.

their specific country circumstances. They must ulti-

The recent deterioration in the quality and cred-

mately decide on a model, or combination of models,

ibility of national political and economic institutions in

for institutional changes that are most likely to lead

a large number of Asian countries is a key concern

to improved performance in their specific country

and a reason why Asia’s rise should not be seen as

context.

preordained. Transparency, predictability and accountability

The governance challenge in Asia

are key elements to establish long-term domestic legitimacy of authorities. These make governance and institutional dimensions, even over a 40 year time

There is no shortage of published indicators that track the governance and institutional evolution of countries over time. While survey methodologies,

1 For the purpose of this report, governance is defined as the exercise of power/authority in the management of a country’s economic and social resources. This exercise of authority is reflected in incentive structures, legal and regulatory frameworks, policy, political and institutional frameworks, institutional capacity, and transparency and accountability dimensions. Governance is imbedded in the political culture and collective perceptions of the citizenry. Institutions are defined as sets of ”rules of the game” (laws, formal processes, systems), including the locus of exercising those rules. Regulations in turn are defined as expressions of formal processes (“rules”) meant to guide the implementation of authorities’ intent. Whereas regulations can be changed in a short span (e.g. 1 to 3 years), institutional changes and development need to be assessed at a minimum over a 10 to 15 year span. Governance evolves incrementally over a long time horizon (decades) unless exposed to sudden and fundamental disruptions such as revolutions and armed conflict.

sources and scope differ, the overall picture points in the same direction. The 2009 Worldwide Governance Indicators published by the World Bank Institute are formed by a composite of six core dimensions: voice (of people) and accountability (of government), political stability/no violence, government effectiveness, regulatory quality, rule of law, and control of corruption. A simple average of the scores of Asian economies does not indicate any major changes between 93

“

It is essential for all Asian countries—

across the three groups—to focus on improving governance and transforming institutions in order to meet the challenges of the coming decades

13

1

Analytic framework for governance and institutions

TRANSFORMING GOVERNANCE AND INSTITUTIONS

The Issue

Actors and instruments

Bad principles

Who leads the Public sector?

Government through economic and social policies

r
Growth-oriented r
Inclusive r
Sustainable development-oriented r
Accountable

r
Lack of clarity of direction r
Exclusive r
Rent-seeking oriented r
Not accountable

How are policies applied?

Through a clear legal, institutional and regulatory framework and related agencies

r
Rule-based r
Equitable (law applies equally to everybody) r
Accountable

r
Ad-hoc r
Selective, captured r
Not accountable

How are policies implemented?

Through/by the civil service and other service providers

r
Competent r
Merit-based, Competitive r
Efficient r
Accountable

r
Incompetent r
Nepotism-based and/ or captured r
Inefficient r
Not accountable

How are resources allocated?

Through the budget process

r
Transparent r
Competitive r
Accountable

r
Non-transparent r
Arbitrary and/ or interest-group oriented r
Captured

How are public oversight functions carried out

Through multiple actors: r
Parliament r
Media r
Civil society r
NGOs

r
Accountable r
Demand for public accountability r
Access to information

r
Non-effective r
Laden with conflict of interest r
Captured

Are there redress mechanisms?

Through sundry appeals and conflict resolution systems (e.g. ombudsmen)

r
Yes

r
No

1998 and 2009; there was a slight deterioration in

terms, especially when compared with the indicators

the voice and accountability component, but a slight

weighted by population (Figures 3 and 4).

improvement in political stability. Adjusting the scores

Looking at the same Asia-7 over time, however,

by GDP shows quite a different picture: the overall

shows a mixed picture: while government effective-

scores improve dramatically, reflecting the share of

ness and regulatory quality have improved substan-

the Asia-7, especially in areas of government effec-

tially, little progress is observed in the other dimen-

tiveness, regulatory quality, and rule of law; however

sions. Disappointingly, even the Asia-7 do not fare too

they are also accompanied by a drop in the scores for

well viz. the rest of the world in any of the dimensions

voice and accountability and political stability (Figures

(Figures 5 and 6).

1 and 2). Comparing the 2009 results between Asia-7 and

94

Good principles

The remaining—mainly non-converging low and lower-middle income—economies are worse than

the rest of Asia, weighted by GDP, Asia-7 outscores

both Asia-7 and developing countries in other regions.

the rest of Asia consistently, with again, the best

In other words, countries’ performance on govern-

scores for government effectiveness, followed by

ance parallels the three tiers of countries used in this

regulatory quality and rule of law. It is noteworthy that

report in discussing economic performance: high

the scores themselves are also strong in absolute

income or developed Asian economies do the best

“

In Asia as a whole, progress in

governance indicators from 1998 to 2009 has been disappointing with the exception of government effectiveness

in governance; the Asia-7 (or converging) economies

Turning specifically to the dimension of controlling corruption the regional differences within Asia are

score the lowest for most indicators (but not all) of

revealing, particularly when weighted by GDP. The

governance.

correlation between economic development and

Figures 1&2

Asia-7 has outperformed the rest of Asia in governance

Governance Indicators (weighted by GDP)

Governance Indicators (weighted by population)

Voice & Accountability

Control of Corruption

0.8 0.6 0.4 0.2 0 -0.2 -0.4 -0.6

Rule of Law

Voice & Accountability Political Stability No Violence

Control of Corruption

Government Effectiveness

Rule of Law

Regulatory Quality Asia 7

0.5 0 -0.5 -1 -1.5

Political Stability No Violence

13 TRANSFORMING GOVERNANCE AND INSTITUTIONS

are the next best; and the non-converging economies

Government Effectiveness

Regulatory Quality Rest of Asia

Asia 7

Rest of Asia

Source: World Bank Worldwide Governance Indicators, 2010.

Figures 3&4

Asia-7 has still underperformed the rest of the world in governance

Asia Governance Indicators (simple average)

Governance Indicators (weighted by GDP)

Voice & Accountability

Voice & Accountability

Control of Corruption

0.6 0.4 0.2 0 -0.2 -0.4

Rule of Law

Political Stability No Violence

Control of Corruption

Government Effectiveness

Rule of Law

Regulatory Quality Asia-7 2009

Asia-7 2003

1.5 1 0.5 0 -0.5

Political Stability No Violence

Government Effectiveness

Regulatory Quality Asia-7 1998

Asia

Rest of World

Asia 7

Source: World Bank Worldwide Governance Indicators, 2010.

95

“

Managing the challenges common to

Asia, be they rapid urbanization, building a fundamentally sound financial sector or fostering entrepreneurship and innovation requires effective governance

13

Figures 5&6

Governance indicators by subregion (weighted by GDP)

TRANSFORMING GOVERNANCE AND INSTITUTIONS

Governance Indicators by Subregion (weighted by GDP) 1.4

Voice & Accountability Control of Corrupon

1.0 0.5 0.0 -0.5 -1.0 -1.5

1.2 Polical Stability No Violence

1 0.8 0.6

Government Eecveness

Rule of Law

Control of Corrpuon (weighted by GDP)

0.4 0.2

Regulatory Quality

0 1996

Central Asia

Northeast Asia

South Asia

Southeast Asia

2000 Asia

2003 Asia 7

2005

2007

2009

Rest of World

Source: World Bank Worldwide Governance Indicators, 2010.

control over corruption clearly emerges. Yet again,

number of Asian countries from successfully

when compared with the rest of the world, even

overcoming the Middle Income Trap.

weighted by GDP, Asia and the Asia-7 lag behind by a

The quality of institutions will be decisive in

significant margin, although the gap is slowly closing.

helping the fast growing countries avoid the Middle

The results point to the following observations: t


In Asia as a whole, progress in governance

lish the basic conditions to move towards sustained

indicators from 1998 to 2009 has been disap-

faster economic growth, social inclusion, attain the

pointing with the exception of government

Millennium Development Goals, and political maturity.

effectiveness, and more modestly, regulatory

t


Income Trap, and the slower growing countries estab-

Managing the challenges common to Asia, be

quality and rule of law, but with a clear retreat

they rapid urbanization, building a fundamentally

in voice, accountability and political stability;

sound financial sector or fostering entrepreneurship

The Asia-7 fare better, but even so, they

and innovation requires effective governance at both

perform worse than the rest of the world in all

central and local government levels, reflecting princi-

dimensions. Unless these shortcomings are

ples of accountability and subsidiarity.

addressed Asia can hardly call itself the leading t


region of the world.

Drivers for change in governance and

In particular with respect to controlling cor-

institutions

ruption, the “governance deficit” with the rest of the world is worrisome. Together with the

Like elsewhere, pressure to change governance

deficits in rule of law, voice and accountability,

and institutions in Asia comes from the domestic front

this key institutional deficit may hinder a large

rather than the external. Three drivers—demographics, urbanization, and the demands stemming from an

96

“

These unprecedented demographic trends

will not only translate into new, more modest economic realities, but also into different intergenerational expectations and relations

expanding middle class combined with a communi-

tion is how these demographic contrasts will play out

cations revolution—will become game changers over

in the decades to come.

13

the next 40 years. Demographics Countries with ageing societies will carry a growThe first driver for change derives from the demo-

ing constituency which is inherently conservative on

graphic outlook for the region (see Annex for more

substantive economic and political reform issues and

detail). Broadly speaking, Asia can be divided into

feels strongly about having earned the right to be

three groups

looked after in terms of health care and pensions.2

t


Countries with rapidly ageing societies, mainly in Northeast Asia where the demographic win-

not only translate into new, more modest economic

dow has already closed or is about to close:

realities, but also into different inter-generational

Japan, Republic of Korea, PRC (with a slight

expectations and relations. Older people are more

lag), and Taipei,China, Singapore, and Thailand.

conservative and more resistant to change. They

By 2050, more than 40 percent of Japanese

prefer stability and certainty over change. These in

and Koreans will be over 65—today already 20

turn will impact on all aspects of governance and call

percent of Japanese are over 60, as are some

for wide-ranging institutional adjustments.

12 to 15 percent of the PRC’s and Republic of

t


Ageing societies will have to adjust economic

Korea’s population. By 2050, Japan’s popula-

structures, institutions and policies to take account

tion will have shrunk by 30 percent. The PRC’s

of the increasing number of elderly. Labor-intensive

working age population will start to decline

industries will disappear as the labor force shrinks.

starting 2015, tailing Japan’s demographic t


These unprecedented demographic trends will

TRANSFORMING GOVERNANCE AND INSTITUTIONS

Ageing societies

Increasingly, technology and innovation will have

decline by roughly years;

to be relied upon to replace labor (in manufacturing as

Countries (many in ASEAN) with a robust

well as in services). Health care (including long-term

demographic balance between working-age

care) and related regulations will have to be adjusted

populations, elders and minors. These can

to the special needs of the elderly, and the looming

still benefit from their demographic window for

shortfall in health care workers will have to be covered

another decade or two.

by opening up labor markets (Japan is an important

Countries with a very large proportion of young

example). Pension and social security payments will

people, whose demographic windows will

increasingly crowd out whatever fiscal space exists.

remain wide open for several decades. This

Local administrations will have to develop “elderly”

group includes some of the poorest and most

oriented service windows, and the adoption of more

fragile countries, many of them in South Asia

active population policies is likely.

and Central Asia. Table 2 provides an overview of these demographic trends, using subregions’ working age population as an important indicator of demographic windows and potential dividends. The crucial ques-

2 The current and prospective ageing generation in Japan prides itself of having rebuilt the country from the ashes of WW II. The same age cohorts in Republic of Korea, Taipei,China and Singapore designed, implemented or oversaw the transformation into the Asian tigers, and the similar age groups in PRC have been at the center of the most massive transformation in mankind from a backward centrally planned, largely rural economy to the largest industrialized economy of the world.

97

“

On the governance front, the pressure will

be on the authorities to deliver economic growth, to raise living standards, to create jobs, and to ensure the public’s consent for legitimacy

13

Table 2

Working age population as a % of total population will begin to decline for all subregions

TRANSFORMING GOVERNANCE AND INSTITUTIONS

2010

2020

2030

2040

2050

Northeast Asia

64

63

60

57

55

South Asia

54

57

60

62

61

Southeast Asia

58

60

60

59

58

Central Asia

56

58

58

59

57

Source: UN Statistics Division, 2010.

A particular challenge for the ageing countries in

the threat of religious extremism and radicaliza-

Northeast Asia (Japan, Republic of Korea and PRC)

tion of the young, and managing the risk of

is that there are no historic precedents. These shared

social unrest. Furthermore, these countries are

challenges may yet open opportunities for coopera-

also rapidly urbanizing—at low income levels—

tion such as peer learning from each other and from

which represents additional challenges for

ageing societies in Europe.

urban management. The implications for economic structures, institu-

“Young and robust” societies

tions, and policies to foster economic development are well known. They represent more traditional devel-

“Young” countries, under a positive scenario,

opment challenges and relate inter alia to improving

will grow the size of their economic pie, and over

the investment climate, competition policies, and job

time improve public services, in a manner similar to

creation; education and skills development; innova-

today’s OECD and other advanced Asian economies.

tion and moving up the value chain; infrastructure

On the governance front, the pressure will be on the

and urban redesign; water, energy, agriculture, and

authorities to deliver economic growth, to raise living

environment; and citizens’ demands for voice and

standards, to create jobs, and to ensure the public’s

participation. It is worthwhile to note that young coun-

consent for legitimacy. These pressures take on

tries are likely to sustain a greater appetite for reforms

contrasting dimensions across different groups of

than the ageing countries.

countries: t


For the converging economies (e.g., India,

Urbanization

many ASEAN countries), it means ensuring the smooth expansion of the middle class,

t


98

The second driver for change derives from the

remaining competitive and moving up the inno-

inescapable trend towards urbanization. Where today

vation and technology ladder, and focusing on

about 40 percent of the PRC’s population is urban, by

productivity gains in order to avoid the Middle

2050 the urbanites will account for over 70 percent;

Income Trap. Investments in people through

the shift in India will be from some 30 percent to over

quality education at all levels will play a big role.

50 percent.

For the fragile states (notably Afghanistan,

Well-run cities with quality amenities (education,

but also some Pacific Island states), it means

health, finance, infrastructure, sanitation, air quality,

rebuilding the authority of the state, coping with

recreational facilities, etc.) will have a decisive edge

“

Although a daunting challenge, the eradication

of corruption is critical for all countries in order to ensure necessary social and political stability and retain the legitimacy of governments

over other, less well-run urban agglomerations. Cities

stronger voice and increased participation, a trans-

will house the knowledge workers, serve as the locus

parent allocation of (budget) resources, accountability

of innovation, and forge enabling institutions. Citizens

for results, and for enhanced personal space. Although a daunting challenge, the eradication of

ers, and increasingly turn to their local government

corruption is critical for all countries in order to ensure

leaders to get results. In turn, powerful mayors will

necessary social and political stability and retain the

increasingly influence national politics, with significant

legitimacy of governments. Here, the quality of com-

changes in center—local fiscal relations and decision-

munication between those who govern and those

making authority. The citizenry will demand more pre-

who are governed will be of paramount importance

dictable, transparent and accountable governance,

as new social media and other as yet unknown—but

possibly via scorecards and similar instruments.

guaranteed to emerge—new tools will not be denied,

The push for decentralization under increasingly federated structures is inevitable. Mayors of principal cities will have increasing sway over national politics,

as recent events in the Middle East and North Africa have amply illustrated. As discussed, with increasing incomes and an

but this will also contribute to tensions between

expanding middle class in Asia, demands for better

national and local governments. Well designed and

services and quality of life will become a powerful

effectively implemented decentralization will make

driver for institutional change. The accumulation of

a huge difference. The global experience has actu-

assets by the middle class will create demands for

ally been quite sobering, pointing to the difficulty of

more efficient financial intermediation, institutions, and

achieving the right balance in center—local relations

instruments. Over time a substantial transfer of wealth

and the importance of institution-building.

from the state to citizens / individuals will occur. This

The challenge lies in identifying the form of

shift will spur further innovation (e.g. in the financial

governance and institutions best suited to the Asian

sector), but also impact center-local fiscal relations,

context. This has large implications for the relation-

public finance management (including debt manage-

ship and distance between the state and its citizens,

ment—now increasingly needed), and give further rise

including the forms of competitive politics at the local

to concerns about income differentials.

level. It points to the need for safeguards against capture and

corruption.3

TRANSFORMING GOVERNANCE AND INSTITUTIONS

will demand competent mayors and city manag-

13

More money in the pockets of citizens, combined with the demographic profile of major Asian countries, will facilitate the shift from an export-oriented model

Asia’s expanding middle class and

of economic growth to a domestic demand-led

the communications revolution

model, with an impact on investments, consumption, and savings. Asia overall is fortunate to be in a

Throughout Asia, an expanding middle class—a

position to address this new challenge in a gradual,

desirable product of rapid socio-economic growth

cautious manner—a luxury that most other regions

in and of itself—will also exert new demands for a

did not have. Yet, the emergence of a newly emboldened

3 Emerging Asia’s “behind the border” responses will not be fundamentally different from those societies that have gone through those transformations historically; thus overall, the evolutionary path will broadly resemble those of the OECD countries also in terms of institutional development, and regulations, including center-local fiscal relations and decentralization.

citizenry should not be equated with a transition into a Western democratic model. Fundamental determinants of governance will not change so soon. The relationship, distance and social contract between 99

“

While politics will increasingly be

contested, civil society and media outside of the formal political system will demand accountability, monitor government performance, and thus exercise public oversight

13

Table 3

Northeast Asia will be the most urbanized subregion in Asia

TRANSFORMING GOVERNANCE AND INSTITUTIONS

Urbanization Rate Northeast Asia

74%

South Asia

55%

Southeast Asia

65%

Central Asia

67%

ticipation and voice by citizen, or conversely, allow for even tighter surveillance by authorities. Events in the Middle East have illustrated the power of communications technologies. The pressures arising from these domestic drivers, needed actions and related risks are summarized in Table 4. The priorities and related principles are

Source: UN Statistics Division, 2010.

elaborated further below. the state and its citizen, and forms of citizens’ par-

Key actors of institutional change

ticipation in the state’s decision making process will for the most part continue to differ from Western

Asian governments will have to be the key actors

parliamentary democracies. This is not to buy into

to realize the Asian Century, but they cannot do it

the overly simplistic view of “Asian values”, but rather

alone. Governments have to design and implement

a recognition that governance will have some “Asian

the sound growth-oriented and inclusive economic

characteristics”. Traditional hierarchal relationships

and social policies that have been discussed through-

embedded in Asian societies will not be set aside

out this report. To do so they must devise enabling

over such a short period.

institutional and regulatory frameworks that are

However, a wild card here is the future of com-

rule-based, thus predictable, equitable and account-

munications. This is not the place to speculate about

able to the citizen. Governments must keep an eye

future technological scenarios, but what seems rather

on corruption and cronyism. Governments also

certain is that we will experience hitherto unimagined

have to be able to rely on a capable civil service and

new communication technologies and tools that may

honest judicial institutions to ensure the sustained

Table 4

Pressures for governance and institutional transformation—domestic

Developments

100

either dramatically accelerate the push for more par-

Priorities

Risks

Demographics

Northeast Asia is ageing, South and Southeast Asia are young

r
Ageing countries should adjust institutions r
Young countries should improve public services

r
No precedent in Asia for adjusting institutions in response to ageing r
Poor delivery of public services can lead to unrest

Urbanization

Urban population growth will be significant through 2050

r
Governance and institutional reforms should account for the urban population growth r
Decentralization policies

r
Urban growth could lead to tensions between national and local governments r
Urban-rural income gaps will likely grow further

Expanding Middle Class

Expanding middle class will lead to demands for higher quality of life

r
Government must keep up with growing expectations and demands for governance and institutional reforms

r
Could lead to demands for more voice r
The distance between state and citizen will be affected

“

Corruption cannot be left unchecked;

else, eventually it will suffocate the foundations of rule-of-law institutions

transition from post-conflict, poor countries to

the exercise of state authority. But developing such

converging economies, or (iii) allow the devel-

capacity is a time-consuming undertaking; smart

oped economies to successfully address the

governments will use the key drivers cited in this

pressing challenge of ageing is the quality of institutions.

report to their advantage, especially the three featured in this chapter (demographics, urbanization, and

2.

Corruption cannot be left unchecked;

the expanding middle class) to accelerate institutional

else, eventually it will suffocate the foun-

change.

dations of rule-of-law institutions. The 2010 Global Corruption Barometer reports

Reflecting Asia’s growth performance, as economies and contractual relations grow more complex,

that—mirroring a global trend—citizens in

governments will gradually respond to these pres-

almost all Asian countries, regardless of

sures by accepting the evolution of a civil society and

income level, middle income or low income,

the private sector. Securing the authorities’ legitimacy

feel that corruption has worsened over the

will translate into their acceptance as rule of law insti-

last three years, with one notable exception,

tutions that reduce the state’s discretion and create

Georgia. Success or failure in dealing with cor-

more space for individuals and social groups alike.

ruption and other governance issues will go a

While politics will increasingly be contested, civil

long way in determining where Asian countries

society and media outside of the formal political sys-

will find themselves on the path towards pros-

tem will demand accountability, monitor government

perity in 2050.

performance (both at national and local level), and

3.

13 TRANSFORMING GOVERNANCE AND INSTITUTIONS

implementation of intended policy directions and

Devise participatory approaches to policy

thus exercise public oversight. The ultimate challenge

making and build accountability mecha-

for Asia will be to maintain this positive momentum for

nisms. Demands for new forms of account-

institutional change over a generation. Failing to do so

ability will rise. Managing the expectations of an

will stunt the dream of the Asian Century.

increasingly vocal citizenry will pose complex challenges to governments.

Principles and priorities

4.

Designing policies is only half the game, enforcing the rules, i.e. implementation is what matters. Policy reforms all too often

Reflecting on the drivers of change, the entry points for governance and institutional change,

remain on paper only and are not implemented

and the results of surveys such as the Worldwide

or enforced. Where the gap between progress

Governance Indicators give the direction that govern-

on paper and observed lack of implementation

ments in Asia should consider, and how they should

is too great, the ensuing disconnect threatens

attain their goals of stability and prosperity. This

to compromise the credibility of governments.

chapter concludes with the following eight principles and priorities: 1.

5.

Ensure that rule of law applies equally to everybody. If the events in North Africa and

Focus on building strong transparent

the Middle East and the various popular upris-

institutions—they are what matters. The

ings in recent years are to serve as a guide,

single most important factor that will determine

the selective application of rule of law—evident

whether Asian countries will either (i) escape

in the arbitrariness of the state and the lack

the Middle Income Trap, (ii) make a successful

of personal security—is the fulcrum of citizen 101

“

Countries must select institutional models

that are likely to yield an improved performance within their specific country context

13 TRANSFORMING GOVERNANCE AND INSTITUTIONS

6.

anger. A particular premium must be put on

consistent, transparent, accountable and

building a judiciary and police that is seen as

verifiable results, and built-in mechanisms of

honest, fair and acting with integrity.

recourse. Mechanisms need to be established

Build a civil service based on merit. The

to replace governments through contestable

government policies. It follows that the qual-

Realize that best practice approaches will not do the trick. Countries have to

outcomes of government actions. A common

adapt for ‘best fit’. Countries must select

feature of the economies that have joined the

institutional models that are likely to yield an

ranks of the developed countries is that their

improved performance within their specific

civil service is seen as honest and highly com-

country context, i.e. the best fit to their

petent. They have been able to attract the best

circumstances.

and the brightest, and successfully institution7.

8.

ity of the civil service has a major impact on the

alized a meritocracy. Realize that a healthy relationship between authorities and citizens is a function of trust. Trust is built through

102

elections anchored in constitutional rights.

civil service is relied on to implement

Realizing the Asian Century: Regional Cooperation and Integration 14 This chapter discusses the five reasons for the

opportunities which, if left unchecked, could

growing importance of regional cooperation for Asia’s

lead to instability or spark conflicts in parts of

future growth and prosperity; presents a framework

Asia. In this context, the European experience

for understanding relations between countries (from

is encouraging and provides useful lessons.

conflict to cooperation); assesses progress to date

t


Fourth, there are many areas that can yield sig-

with regional cooperation efforts in Asia; identifies

nificant synergies and positive spillovers, such

priority areas to facilitate future regional coopera-

as technological development, energy security,

tion; and finally, discusses institutions for regional

disaster preparedness, etc. that will benefit

cooperation.

from increased collaboration. t


Fifth, the skillful and joint management of

Regional cooperation matters

several regional commons will become increas-

for Asia’s future

ingly important for Asia’s long-term stability and prosperity. The management of the regional

Greater regional cooperation within Asia as a whole will become significantly more important over

commons will involve: t


and social risks associated with drugs,

time for five reasons: t


religious fundamentalism and terrorism.

First, regional cooperation has the potential to be an important bridge between the interac-

t


Avoiding conflicts between the mega economies or nuclear states.

tions of individual Asian countries and the rest of the world. In order to have the voice and

Diffusing and mitigating internal political

t


Maintaining social and political stability

influence in the global agenda that is com-

in the region, especially to support the

mensurate with its economic weight, Asia will

economic and security concerns of fragile

need to formulate a unified geopolitical position

states.

on a range of global issues. This can be only achieved through genuine regional dialogue

Cooperation instead of conflict

and cooperation. t


t


Second, Asia will need to increasingly rely on

Of course, institutional cooperation is not the only

“internal” (domestic and regional) demand

mode of interaction among neighbors. They may also

and open its markets to neighboring countries

compete or be in conflict. In fact, regional coopera-

in the region, in the same way that US and

tion, regional competition and regional conflict are

European markets have been open to Asia

part of a continuum of relations among neighboring

since World War II, in order to sustain region-

states. Conflict involves the attempt to resolve differ-

wide economic growth. This will require the

ences of interest among neighbors through hostile

creation of a single market—at least for goods,

and mutually damaging means; competition engages

services and finance, to permit the Asia-wide

countries in the pursuit of resources or benefits to

free flow of trade and investments.

each other’s exclusion, but through peaceful means

Third, regional cooperation and development

and in ways regulated by international law, intergov-

assistance will be crucial ingredients in reduc-

ernmental agreements, or accepted norms; and

ing cross-country disparities in income and

cooperation means working together as partners in 103

“

regional cooperation, regional competition

and regional conflict are part of a continuum of relations among neighboring states

14 REGIONAL COOPERATION AND INTEGRATION

maximizing common or shared benefits. In general,

also can be pursued through cooperative solutions

neighboring countries should aim to reduce or

based on coordinated reductions in protection and

eliminate conflict, because of the great human and

improvements in border and transit management.

economic damage that it causes.

Transport involves regional cooperation where national transport links connect across borders

Depending on the specifics of the situation, competition may provide incentives for improved

(especially when part of agreed regional transport

performance, i.e., “race to the top” (e.g., competing

corridors). However, nations can also compete

for foreign direct investment through reform in the

through transport investments, e.g., by developing

business climate); or it may involve costly duplication

competing port or airport capacity or by building

of investments or loss of resources, i.e., “race to the

competing regional road or railroad lines. In the case

bottom” (e.g., competing tax incentives for direct for-

of water (as well as maritime resources), interstate

eign investors). Cooperation usually will be the most

relations can run the gamut from conflict to competi-

desirable approach, provided it is not at the expense

tion to cooperation. For disaster preparedness, there

of or threatening third parties.

is no obvious room for conflict and competition, but plenty of opportunity for cooperation. Conflict

Figure 1 shows the typical range of relations between countries in specific areas of regional sig-

prevention is in principle a cooperative activity, but in

nificance along the spectrum from conflict through

practice it gets wrapped up in interstate and geopo-

competition to cooperation. For example, trade policy

litical conflict and competition, as the current situation

traditionally can involve measures to gain national

on the Korean Peninsula demonstrates. Of course,

benefits from protection in a competitive mode, but

sometimes a history of painful and bloody conflict

Figure 1

From conflict to cooperation

Trade policy and trade facilitaon Transport Energy Water Finance Technology Health/Epidemics Disaster preparedness Food security Conict prevenon (domesc, cross-border) Drugs/Crime

CONFLICT

COMPETITION Preferred Direcon of Change

104

COOPERATION

“

Although there remain constraints to

economic integration, the Asia region as a whole has been increasingly open to trade

Box 1

Moving towards cooperation without conflict: learning the lessons of history

human losses and economic dislocation. Born out of this experience, Europe managed to create

of past integration and cooperation. Without

during the second half of the 20th Century the

a minimum of trust, little can be achieved in

regional cooperative institutions that have allowed

regional cooperation, institution building and

it to overcome a history of harmful conflict and

conflict prevention. Asia can learn from history.

unproductive competition and to attain shared

Perhaps the most important lesson is to avoid

prosperity and peace. Asians can learn both

the mistake that Europe made during the first half

from European history as well as from their own

of the 20th Century. After a golden era of rapid

experience of moving successfully from conflict

industrialization, growth and integration during

to cooperation (as in the case of ASEAN and the

the second half of the 19th Century, Europe

Greater Mekong Subregion Program). They now

entered the 20th Century with great expectations

have an opportunity to enhance mutual trust

for continued growth and prosperity. In fact,

and strengthen the regional institutions that will

however, Europe repeated its errors of previous

allow Asia to avoid the ravages of conflict and

centuries and fell into 30 years of intense conflict

continue its growth performance to achieve lasting

and two world wars, which caused unfathomable

prosperity and stability.

may be a driver for cooperation, as was the case with

Progress to date with regional economic

the creation of the European Union (Box 1).

integration

REGIONAL COOPERATION AND INTEGRATION

Looking ahead the big opportunity for Asian regional relations is to build on the successes

14

A key element in moving from regional conflict to constructive competition and cooperation is

Although there remain constraints to economic

the establishment of trust among the neighbors.

integration, the Asia region as a whole has been

One of the benefits of looking at the full range of

increasingly open to trade. Its trade to GDP ratio

regional integration and cooperation areas across

reached roughly 62 percent in 2008, only 3 percent-

the spectrum of cooperation-competition-conflict

age points lower than the EU, and much ahead of

is that it allows priorities, tradeoffs, and risks to be

Latin America or Africa. While historically relying

better identified. For example, by focusing regional

especially on trans-Pacific trade, Asia’s trade and

relationship-building on those areas where there is

non-trade economic links with Europe have been

little room for conflict and competition, trust can be

expanding rapidly since the dissolution of the Soviet

established among neighbors; on the other hand,

Union, offering new opportunities for cross-continen-

neglecting areas that are prone to conflict may

tal integration of Eurasia.

interfere with cooperation in other areas, if and when conflict breaks out.

As regards intra-regional trade, Figure 2 shows how the Asia region has been integrating rapidly since 1960: its intra-regional trade share rose from about 20 percent to over 50 percent in 2008. Largely driven by market forces and complemented by national policies, economic interdependence in East and 105

“

The key drivers of regional economic

integration relate to the costs of trading, infrastructure, the competitiveness and quality of institutions, and conflict

14

Figure 2

Asia has experienced an increase in share of intra-regional trade

REGIONAL COOPERATION AND INTEGRATION

Source: World Bank World Development Indicators, 2011. Note: Figures refer to total trade (exports plus imports). The intra-regional trade share of region i is defined as IT sharei = (Xii+Mii)/(Xi+Mi), where Xii = exports of region i to region i; Mii = imports of region i from region i; Xi=total exports of region i; and Mi = total imports of region i

Southeast Asia has grown rapidly in recent decades.

that of the EU (about 75 percent). Across different

Intricate regional production networks and supply

subregions within Asia, East Asia is the most inte-

chains have been established in industries such as

grated subregion, although labor and monetary/finan-

electronics and cars. This process has resulted in

cial integration remain low. For all other subregions,

fragmentation of production—the scattering of parts

the degree of integration remains low in terms of labor

of the production process across different econo-

and financial integration.1

mies—and led the process of regional and global integration. This has stimulated foreign direct investment,

Drivers of economic integration

deepened trade in intermediate goods, and boosted growth in the region. Intra-regional trade in parts and components has

The key drivers of regional economic integration relate to the costs of trading, infrastructure, the com-

increased as the pattern of regjional production has

petitiveness and quality of institutions, and conflict. An

become more specialized. FDI flows have gravitated

analysis of these determinants leads to the following

to PRC, especially after the 1997-8 Asian crisis. PRC

conclusions:

has become the main assemblly plant for “Factory

t


There have been many improvements in the

Asia” and emerged as a significant export for other

Asian drivers of integration and economic

East and Southeast Asian economies, as well as a

growth in recent years, especially in East Asia.

base for final goods to the rest of the world.

These have contributed substantially to the

This level of trade integration exceeds that of

region’s superior growth performance.

North America (about 40 percent), but falls short of 1 Central Asia’s labor markets are a notable exception. They are moderately integrated due to intra-regional migration, especially migration from Central Asia to The Russian Federation.

106

“

Continued integration will be the

result of continued high growth, savings and investment, and in turn will be a driver of continued high growth

t


However, Asia generally still falls behind the

of institutions and the competitiveness of all

performance of the EU and North America in

economies.

key areas that relate to trading costs, trans-

t


Reduce or eliminate the distrust and conflicts within and among countries that have created

infrastructure, competitiveness and institutional

the barriers to integration.

Trade tariffs are generally not a significant

Prospects for further economic integration

barrier anymore, but other border barriers (e.g. quantitative restrictions, border administration and even closures, etc.) and behind-the-border

is large. Continued integration will be the result of

constraints (related to logistics, transport,

continued high growth, savings and investment, and

infrastructure problems, weak institutions, etc.)

in turn will be a driver of continued high growth.

remain significant barriers to integration. t


t


t


The scope for further Asian economic integration

East Asia does substantially better than South

A number of factors argue for this prognosis: t


Under all likely growth scenarios Asia’s econ-

Asia and Central Asia on most drivers. ASEAN

omy will continue to grow relative to the rest

performs especially well where overall trading

of the world. By 2050 Asia will likely represent

costs are concerned.

more than 50 percent of the world market.

South Asian countries have generally improved

t


The need for some Asian countries to rebal-

their economic performance in recent years,

ance their economies away from exports to the

with India the best performer and rapidly

rest of the world, and especially from the US,

improving on many dimensions.

and re-orient them towards domestic and intra-

There are great differences in country perform-

regional consumption provides a strong impetus for further economic integration of Asia.

ance within the subregions. Looking ahead, therefore, the challenges for con-

t


Recent trends in Asia’s integration drivers

tinued, rapid Asian integration and growth between

show that the barriers to integration have been

now and 2050 include the following:

reduced not only in East Asia but also in South

t


t


t


Improve the effectiveness of integration drivers

Asia (see Box 2). India has been success-

to levels that are either as good or better than

ful in fostering bilateral trade with its smaller

those of the EU and North America.

neighbors and with PRC. Central Asia has so

Ensure that the subregions, and countries

far made the least progress. Given Asia’s prag-

within subregions that lag behind, catch up

matic approach to economic policy making,

with the rest of Asia.

there is every reason to believe that the trend

Go beyond reducing and harmonizing tariff

towards increased integration will continue.

barriers and focus instead on non-tariff trade

t


REGIONAL COOPERATION AND INTEGRATION

port and logistics, the quantity and quality of quality. t


14

t


One of the drivers of integration within Asia (in

facilitation measures, both at and behind

particular of Central Asia’s links with East and

borders.

South Asia) will be the trans-Eurasian continen-

As regards the behind-the-border measures,

tal integration process. This process places the

improve the quantity and quality of infra-

land-locked countries and regions of Central

structure, the quality of logistics, the quality

Asia (including Afghanistan and Western PRC) at the hub of growing economic links between 107

“

South Asia is a relative late-comer to

regional cooperation and integration

14

Box 2

Regional cooperation and integration in South Asia

REGIONAL COOPERATION AND INTEGRATION

South Asia is a relative late-comer to regional

and visitor services; and enhancing natural and

cooperation and integration. The South Asian

cultural heritage. Discussions are ongoing to

Association of Regional Cooperation (SAARC),

expedite the service connection agreements for the

established in 1985, is the first regional cooperation

regional information highway network, formation of

initiative in South Asia. Heads of States of

community e-centers, and conduct of ICT research

Bangladesh; Bhutan; India; the Maldives; Nepal;

and training.

Pakistan; and Sri Lanka participated at the first

In January 2010, Bangladesh and India

SAARC Summit in Dhaka in 1985. SAARC had

signed a wide-ranging economic cooperation

been once described as “act of faith” given the

agreement that provides a comprehensive

absence of shared security threat and low level of

framework for cooperation in water resources,

formal intra-regional trade and investment.

power, transportation, tourism and education.

The need to accelerate and complement

The agreement also allows the use of Mongla and

the SAARC progress spurred four countries in

Chittagong sea ports for movement of goods to

SAARC, namely Bangladesh, Bhutan, India, and

and from India through road and rail. Bangladesh

Nepal, to form the South Asia Growth Quadrangle

also conveyed the intention to give Nepal and

(SAGQ). At the request of SAGQ, ADB initiated the

Bhutan access to Mongla and Chittagong ports.

South Asia Subregional Economic Cooperation

The agreement envisages energy trade between

(SASEC) program in 2001 as the first formal and

the two countries. To support this initiative, ADB

comprehensive subregional cooperation initiative

developed and financed the Bangladesh–India

in South Asia. The SASEC program provided a

Electrical Grid Interconnection Project in August

forum for the four countries to discuss, identify

2010.

and prioritize cooperation projects in transport,

South Asia’s interest to develop closer

energy, environment, trade, investment, private

collaboration with other regional groupings has also

sector development, tourism, and information and

grown. Countries in South and Southeast Asia have

communication technology. The project based

started inter-regional cooperation initiatives such

approach of SASEC complements the policy and

as the Bay of Bengal Initiative for Multi-Sectoral

dialogue driven mechanism of SAARC.

Technical and Economic Cooperation (BIMSTEC)

SASEC has resulted in two important regional

to pursue inter-regional cooperation. The BIMSTEC

projects that were developed and supported by

is an important vehicle to facilitate integration

ADB —SASEC Information Highway Project

between South Asia and South-East Asia, the

and the South Asia Tourism Infrastructure

realization of which is critical for the achievement of

Development Project. The latter aims at improving

Pan-Asian regional cooperation and integration.

connectivity, providing better quality environment

the growth centers of East and South Asia, and the economies of Europe and the Russian Federation (Box 3). 108

There are two significant risks that could derail this continued integration process:

“

One of the drivers of integration within

Asia (in particular of Central Asia’s links with East and South Asia) will be the transEurasian continental integration process

Box 3

14

Central Asia’s triple integration opportunity

improvements in the domestic business climate, in regional infrastructure investments and in border

—as isolated economies, land-locked and distant

management. Central Asian integration would also

from world markets. While this has been true in

get a strong boost, if all countries were to promptly

the past, Central Asia now has huge opportunities

join the WTO. Estimates show that the cost of

due to its proximity to the buoyant markets of Asia

trade could be halved through appropriate trade

and its location at the hub of a rapidly integrating

facilitation measures. With cooperation across a

Eurasian super-continental economic space. On

wide range of potentially beneficial areas, Central

top of this, Central Asian economies can benefit

Asian GDP could double.

from greater integration among themselves. To take advantage of this triple opportunity,

Overall, the key to benefitting from the triple opportunity will be to build stronger economic links

Central Asian countries can build on a relatively

to East and South Asia, complementing Central

well developed infrastructure and still strong human

Asia’s existing strong ties with the former Soviet

capital, and on the fact that they have relatively

Union economies.

open trade regimes. However, they also need

REGIONAL COOPERATION AND INTEGRATION

Central Asian countries have traditionally seen themselves—and have been seen from the outside

Central Asia has a regional economic forum,

to overcome some severe handicaps, imposed

CAREC, which over the first ten years of its

mostly by their own weak policy regimes and

existence has contributed to improved trust,

failure to effectively cooperate with each other to

investments in regional transport and energy

date. Their infrastructure is deteriorating rapidly

infrastructure and the facilitation of regional trade.

in the absence of effective management and

With a membership of ten countries, including

maintenance, their borders with each other and

Afghanistan, Mongolia, Pakistan and PRC, and

many of their neighbors have become serious

with support from six multilateral institutions, led

obstacles to cross-border and transit trade,

by ADB, the capacity of CAREC to intensify its

their behind-the-border business conditions are

efforts to support regional integration within the

stifling private investment and trade, and failure to

region and beyond is very significant. However, it

cooperate in the management of regional water

does require the active engagement of all member

and energy resources creates severe economic,

countries at the highest level and a willingness of all

social and environmental losses as well as risks

participants to overcome what are still high barriers

of serious inter-state conflicts. These obstacles

to integration and risks of conflict.

need to be overcome by much more aggressive

t


Asian economies do not further reduce barriers to integration, fail to build the necessary crossborder infrastructure and improve the behindthe-border conditions that support domestic growth and cross-border integration.

t


International conflicts, failing states and internal unrest get in the way of continued integration (see Chapter 5 Box 2).

These risks call for strong regional dialogue and collaboration among the countries of Asia and with 109

“

Asia will need to develop its own unique

model that builds on the past positive experience in East Asia: a market-driven, bottom-up and pragmatic approach

14

the international community to assure that the neces-

Priority areas to facilitate regional

sary conditions for continued economic integration

cooperation

within Asia and with the rest of the world are realized. REGIONAL COOPERATION AND INTEGRATION

It will be important to avoid conflicts that disrupt the

The key areas where cooperation can assure

integration process from proceeding smoothly and

shared interests include trade and transport policy,

that support the continued rapid growth of the Asian

macroeconomic coordination, cooperation on finan-

economies.

cial integration and stability, and access to natural resources. Cooperation is also needed to counter

Contours of future cooperation

common regional threats (e.g., natural disasters,

and integration

epidemics and drug trade) and prevent conflict. With this long list of cooperative opportunities and chal-

Regional cooperation and integration are critical

lenges the question is which priorities regional leaders

for Asia’s march towards prosperity. Asia will need

should focus on in the coming decades for the long-

to develop its own unique model that builds on the

term stability and growth of Asia. We recommend the

past positive experience in East Asia: a market-driven,

following priorities:

bottom-up and pragmatic approach that facilitates

t


flows, with a degree of labor mobility throughout the

t


Invest in regional transport and communications infrastructure.

region. As the European and East Asian experiences have amply demonstrated, production networks

t


Assure regional energy security.

facilitated by the free flow of goods and services help

t


Address the regional challenges of climate change adaptation and disaster preparedness.

both the lower wage economies by bringing new investments and technical know-how and the higher

t


Provide bilateral and multilateral assistance

income economies by allowing them to preserve their

to countries that lag behind, to facilitate their

core manufacturing capacity by “outsourcing” lower

integration.

value-added activities to lower wage areas.

t


Foster people-to-people exchanges, such as professional networks, cross-country volunteer

This bottom up, market driven model could use ASEAN + 3 as the initial building block and gradually

programs, etc. to foster personal contacts and

include more economies over time, preferably a com-

to build mutual understanding, goodwill and

mon market that would also permit more labor mobil-

trust.

ity, including of skilled workers. In the process, Asian

t


Create a high-level political forum to help

countries will develop stronger mutual trust that is

resolve, when possible within the region,

necessary for any subsequent, more ambitious initia-

actual and latent conflicts, including river basin

tives (like the creation of a genuine single market that

issues, before seeking help and intervention

will require supra-national institutions). The sooner

of extra-regional parties (whether national or

such a Pan Asian free trade is created, the sooner

multilateral).

would a larger number of Asian economies gain concrete benefits from the growth of the Asia-7 countries. Such an approach will require stronger—though not necessarily new—regional institutions. 110

Reduce barriers to integration at and behind the borders.

unhindered regional trade, services and investment

“

“Open regionalism” (i.e., the creation of

institutions that are open to extra-regional participation and do not discriminate against non-regional economies in the longterm), is the most successful strategy

Institutions for regional cooperation

7.

“Open regionalism” (i.e., the creation of institutions that are open to extra-regional participation and do not discriminate against

forums and programs. Asia’s regional institutional

non-regional economies in the long-term), is the most successful strategy.

system currently has few explicit rules. It is informal, flexible and consensus-based, with either weak or

8.

Regional economic cooperation organizations

non-existing secretariats. Arbitration and enforcement

that involve ministries of finance or economy

either do not exist or are non-binding; there is either

tend to be more effective than those that rely

no or limited monitoring and evaluation of country

on the leadership of ministries of foreign affairs.

or institutional performance. This weak institutional

9.

The engagement of the business community

regional system is the logical outcome of the strong

and civil society strengthens the mechanisms

sense of national identity and sovereignty of Asian

for regional cooperation.

governments and people. A review of the structure of regional cooperation initiatives worldwide and Asia’s regional opportunities and challenges concludes with these ten lessons: 1.

3.

10. Monitoring and evaluating the performance of countries under regional agreements is important, as are incentives for better compliance. Among the existing subregional programs and

Regional cooperation is not easy and imple-

institutions in Asia, ASEAN, CAREC and GMS have

mentation of stated intentions is frequently

internalized many of these lessons. In fact they were

weak. The experience of the EU with its

identified as the more successful of the non-EU

strong supra-national regional institutions (the

regional institutions worldwide. In the rest of the world

European Commission, President, Parliament,

there are few initiatives—outside the EU—that can

Court, etc.) is the exception and difficult to

match their performance.

emulate. 2.

REGIONAL COOPERATION AND INTEGRATION

Asia has a multitude of regional organizations,

14

Nonetheless, Asia cannot be complacent. There

Effective regional cooperation and integration

are many more opportunities to be reaped from

take time to develop, and require incremental,

further integration and cooperation, especially in

gradual and flexible implementation with visible

those subregions that lag behind. But there also exist

payoffs.

significant threats that require regional interventions

It helps to keep the number of members

for maximum effect.

in the regional organization manageable. Membership is best based on shared geogra-

Prospects and institutional options

phy and common regional interests. 4. 5. 6.

Adequate funding mechanisms for regional

In recent years, key Asian leaders have called

investments are essential.

for an Asian community with shared interests and

Successful cooperation requires leadership at

cooperation. Such support would open the door for a

the country, institutional and individual level.

more cohesive, cooperative and integrated Asia than

External assistance can be helpful in setting

has been the case in the past. Consistent with these

up and sustaining subregional institutions, as

statements, the ADB in 2008 set out an ambitious

in the case of the Greater Mekong Subregion Program (GMS) and the Central Asia Regional Economic Cooperation Program (CAREC). 111

“

a crucial prerequisite to achieve increased

regional cooperation is strong political support and leadership. Collaboration between the three mega economies—PRC, Japan and India—remains especially crucial

14

Box 4

ADB proposals for new regional institutions

REGIONAL COOPERATION AND INTEGRATION

Key proposals put forward by ADB in its recent

r


study on Asian regional institutions include: r
r


Initiative to an Asian Capital Markets

Establishing an Asian Financial Stability Dialogue.

Initiative. r


Setting a cooperative framework for

Setting up an Asian Monetary Fund (AMF)

dealing with capital flows and regional

to conduct regional macroeconomic

exchange rates.

surveillance and provide financial support

r


during crisis. r


Broadening the Asia Bond Markets

Working toward a region-wide FTA and multilateralizing regionalism in the WTO

Creating an Asian Infrastructure Fund.

context. r


Setting up an Pan-Asian Infrastructure Forum

Source: Institutions for Regionalism, ADB, 2011.

vision for Asian regional integration and cooperation by

facilitation and in behind-the-border policy

20202. This vision remains appropriate—provided expec-

reforms for greater integration. t


At the global level, Asia could pursue a

tations are kept realistic. An Asian community, based

stronger regional stance within global inter-

on shared interests and increased cooperation, is not

national institutions and fora. The ADB in its

likely to be achieved in the next ten years, but could

recent flagship publication proposed a number

be achieved over the next forty years.

of specific institutional innovations that deserve

It will be necessary to show more institutional innovation to ensure that existing institutions are more

careful consideration (Box 4). Third, a crucial prerequisite to achieve increased

cohesive and effective. This could take place at four

regional cooperation is strong political support

levels: subregional, Asia-wide, inter-regional (with

and leadership. Collaboration between the three

Europe and the Americas especially) and globally:

mega economies—PRC, Japan and India—remains

t


t


t


At the subregional level, the examples of GMS

especially crucial. These three economic giants will

and CAREC can serve as models for other

have to assume clear and cooperative leadership in

subregions.

the region by supporting the creation of open, well-

At the Asia-wide level, a gradual expansion and

connected markets among each other and for their

deepening of the ASEAN+ approach provides

smaller neighbors. They could shoulder the respon-

the best institutional prospects.

sibility for fostering stable political conditions and the

At the inter-regional level APEC and ASEM are

convergence of economic conditions in the Asian

good starting points for greater engagement

economic neighborhood. It will be particularly impor-

with the neighboring regions, with a focus on

tant that the three powers settle their distrust and

improvements in physical connectivity, in trade

work together (if necessary with partners outside the region, e.g. the US and the EU), to assure that other

2 Long-Term Strategic Framework, Manila: Asian Development Bank, 2008.

112

conflicts in the region are prevented or terminated

promptly. In this context, one or more medium sized economies, such as Republic of Korea and Indonesia,

14

may play a useful role in facilitating regional cooperaREGIONAL COOPERATION AND INTEGRATION

tion and collaboration.

113

Realizing the Asian Century: Asia’s Role in the World 15 Asia’s growth and much larger footprint in the

and defender of the global commons. Its efforts to

global economy will bring with it new challenges,

enhance regional cooperation must not be at the cost

responsibilities and obligations.

of Asia’s traditional openness to the rest of the world.

This has far reaching implications for the region’s role in the world, how it sees its long-term self-interest

Asia must adhere to its long-standing strategy of “open regionalism”.

and how it interacts with other parts of the world. Asia will need to rethink its role on a very wide

Global trading system

range of issues and institutions: from its stake in the global commons—global trade and financial sys-

East Asia’s growth since the 1950s was greatly

tems—to its relation to other regions, to the implica-

facilitated by an increasingly open global trading

tions of domestic and regional policies for others, to

system. As discussed in Chapter 2, Asia has profited

Asia’s role in international development assistance in

handsomely from such globalization. Today, Asia’s

Africa and so on. It is also obvious that global peace

trade to GDP ratio is the highest amongst the major

and security are a prerequisite for Asia’s economic

regions. In the future, even as domestic and intra-

and social well-being. The region will need to fun-

regional markets account for a larger share of Asian

damentally transform its role in global governance.

economies, the region will need to continue to trade

These related implications are discussed below.

heavily with the rest of world to supply the ultimate consumers in North America and Europe, acquire

A rising stake in the global commons

the latest technologies and the know-how wherever they exist in the world, and import natural resources

The central implication of Asia possibly account-

(energy; other minerals, food) needed by the domestic

ing for half or more of global GDP and population

economies. In short, it is of vital interest to Asia that

by 2050 is that the center of gravity of the global

the world continues to have an open and free trading

economy will shift gradually from the Atlantic Ocean

system.

to the Pacific Ocean, and ultimately to mainland Asia. As Asia becomes the heart of the global

Global financial system

economy, it will be absolutely important for Asia’s own well-being that the global commons on which

Finance is global, and therefore while national

the global economy depends and prospers continue

reforms are necessary and regional cooperation

to function effectively and efficiently. As a result, Asia

desirable, they are not sufficient. Therefore, Asia

will become the biggest stakeholder in the global

must also pay much more attention to the health and

commons, including an open trading system, a stable

robustness of the global financial system.

financial system, international rule of law, and, of

With its enormous savings and investment rates

course, in peace and security throughout the world.

Asia should host some of the largest global equity,

Without these global commons, Asia will not be able

debt and banking markets well before 2050. It is

to grow and prosper.

already the biggest holder of global reserves. As a

Accordingly, Asia must take greater ownership of

region heavily reliant on trade, Asia would therefore

the global commons. Indeed, in its own self-interest,

have huge stakes in a well-functioning and fair inter-

the region should become a forceful advocate

national monetary system and related institutions. It 115

“

Asia will become the biggest stakeholder

in the global commons, including an open trading system, a stable financial system, international rule of law, and, of course, in peace and security throughout the world

15 ASIA’S ROLE IN THE WORLD

will be in Asia’s vital interest that the global financial

secondary role. In line with the rise in its share of the

systems are sound and efficient (in addition to its own

global economy and thus its rising stake in the well

domestic and regional financial institutions and mar-

being of the rest of the world, Asia needs to devote

kets). This is necessary for the region’s savers to have

greater intellectual and material resources—jointly

acceptable risk adjusted returns and for its econo-

with Europe and North America—to the economic,

mies to have access to investment funds at rates that

social and political stability of the world as whole. The

are competitive with investors elsewhere.

change in Asia’s role is neither necessary nor will it

Given its rising weight in global reserves, savings and investments, the region will have an opportunity

come immediately, but it will happen gradually. But Asia needs to start preparing for it soon.

to increasingly shape the global financial architecture, the monetary system and global financial intermedia-

Relations with other parts of world

tion. As discussed below, Asia needs to play an active and constructive role in the governance of the global monetary and financial system.

This report has used a pragmatic definition of Asia (Central Asia, East Asia and South Asia); this definition has proven useful in considering Asia’s long-

Stance on climate change

term economic prospects. But at the same time, it is important to recognize that Asia already has and will

As discussed in detail in Chapter 11, Developing Asia’s stance on climate change requires a fundamental reassessment. Analysis carried out for this

continue to have close economic political and security relations with countries and regions both near and far. For example, different Asian economies have

study demonstrates that early and aggressive action

strong economic relations and ties with countries

on climate change is in Asia’s own self-interest—

near by: with the Gulf countries and the Russian

socially, economically and politically. A change in its

Federation for petroleum supplies; with Australia and

current stance will also be an early demonstration to

New Zealand for food, coal and other minerals; and

the world community that Asia is willing and able to

with Turkey as a conduit for trade with the Middle

play a constructive role in the global commons.

East and Europe. More recently, Asia’s giant economies, PRC and India, have followed the footsteps

Stake in global peace and prosperity

of Japan to seek closer economic ties with Africa and Latin America to secure access to both mineral

As Asia becomes the center of the global economy, it will be in its own self-interest that the rest

ASEAN countries) have close political and security

of the world is also doing well economically and politi-

relations with the US as well as Australia.

cally. Peace and security throughout the world will be essential for its own long-term prosperity. Since the end of World War II and until now, Asian

Such economic and political relations with other parts of the world will become even more important in the future. They must not be allowed to suffer even

countries have not felt the need to play a proactive

as Asian economies redouble their efforts at regional

role in sustaining global peace and security. The

cooperation and integration.

western powers were keen and able to play that role. But, it may no longer be adequate for Asia to play a 116

resources and export markets. Many countries (e.g.,

“

To play a proactive role in global rulemaking

and enforcement, Asia must pursue a stronger regional stance in global international institutions

Impact of national and regional

and the competiveness of individual economies and

policies on others

economic entities.

15

To play a proactive role in global rulemaking and enforcement, Asia must pursue a stronger regional

Great Recession, in today’s globalized economy

stance in global international institutions (Financial

major developments or crises in the largest econo-

Stability Forum, BIS, WTO, etc.) and political forums,

mies can lead to contagion in other parts of the world.

such as the G-20, APEC and the UN Security

Such transmissions are not limited to crises alone.

Council.

Indeed, changes in major—monetary, exchange rate,

To perform a leading role in the above global

fiscal, immigration—policies of large economies can

apex decision making bodies, Asian leaders, in addi-

have significant effects on others, both near and far.

tion to responding to the proposals put forth by the

Accordingly, as the relative size of individual Asian

traditional global powers (G-7/8), must be capable of

economies and the region’s global footprint expands,

proactively tabling their own constructive ideas and

the region will need to pay greater attention to the

proposals.

impact of its actions on others. While formulating their

Given the complexity of the issues discussed in

domestic or regional policy agenda, the region as a

such bodies, Asian leaders will need to be supported

whole but also the larger economies—PRC, India,

by cadres of world class institutions and professional

Indonesia, Japan and Republic of Korea—would also

experts—in related government bodies as well as

need to take into account the regional and global

local think tanks and academic institutions.

implications

ASIA’S ROLE IN THE WORLD

As was vividly demonstrated during the 2007-9

Clearly, not every country in the region can develop such capacities. Asia will therefore need to

Global governance

develop regional institutions and thinktanks for this purpose.

If it realizes the Asian Century, the region will need to significantly change its role in global governance

Managing Asia’s rise

and rulemaking. It will have to gradually transform its role as

Finally, Asia must delicately “manage” its rapidly

essentially a passive onlooker in the debate on

rising role as a major player in global governance in

global rulemaking and a reticent follower of the rules

a non-assertive and constructive way. As an emerg-

to being an active participant in the debate and a

ing global leader, Asia should act and be seen as a

constructive formulator of the rules. How these global

responsible global citizen.

rules are formulated, supervised and implemented— WTO protocols, BIS rules, IMF guidelines and so on—can have an enormous impact on the costs

117

16

The Asian Century vs. the Middle Income Trap: Dramatic Difference in Outcomes

This chapter compares the outcomes for Asia

The basic idea behind constructing the two

under the Asian Century and Middle Income Trap

scenarios with such different outcomes was to vividly

scenarios. This comparison is followed by a discus-

demonstrate what is at stake today, and what are the

sion of four overriding intangibles that will prove deci-

potential costs and benefits of the countries’ efforts,

sive in determining whether Asia realizes the Asian

both individually and collectively. Where Asia ends

Century or not. Finally, it emphasizes the human

up in 2050 within this range will have a tremendous

dimension of the two outcomes.

impact on the well-being, lifestyles and happiness of future generations of Asians, as well as societies

Cost of missing the Asian Century

around the world. The pie charts in Figure 1 illustrate the differences

Achieving a potentially historic transforma-

in the basic economic parameters— the percent

tion throughout a region that encompasses half of

shares of the global economy, absolute GDP, and

humanity will depend primarily—though not exclu-

GDP per capita (in PPP terms)—under two scenarios.

sively—upon the Region’s effectiveness in managing

The differences are dramatic indeed (Table 1).

the aforementioned mega challenges and risks and

Asia’s GDP per-capita (in PPP terms) under the

tackling the inter-generational issues discussed in this

Middle Income Trap scenario would be about half

report.

($20,300) compared to that under the Asian Century

Admittedly, the agenda—national, regional and

scenario ($38,600). Similarly, Asia’s GDP (at market

global—is truly wideranging and demanding. But, the

exchange rates) in 2050 would reach only $61 trillion,

promise of an Asian Century is the prize. It more than

or 32 percent of global GDP as compared to $148

justifies the extraordinary effort, discipline, patience

trillion, or 51 percent of global GDP.

and enlightened leadership required to address the agenda. Figure 1

Asian Century vs. Middle Income Trap Asian Century Scenario

Sub Saharan Africa 2%

Middle East & North Africa 3%

Rest of World 1%

Europe 18% Asia 51% Lan America & Caribbean 10%

North America 15%

Asia GDP: $148 trillion

Middle Income Trap Scenario Middle East & North Sub Saharan Africa 5% Africa 3%

Europe 26%

Lan America & Caribbean 9%

Rest of World 2%

Asia 32% North America 23%

Asia GDP: $61 trillion

Source: Centennial Group projections.

119

“

four overriding non-tangibles will ultimately

determine the region’s ability to resolve them and thereby shape Asia’s long-term destiny

16

Table 1

Economic 2050 outcomes under two scenarios—Asian Century and the Middle Income Trap

THE ASIAN CENTURY VS. THE MIDDLE INCOME TRAP: OPPORTUNITY COST

Share of Global GDP (MER)

t


Second, the willingness and ability of all Asians to adopt and pursue pragmatic—rather than ideological—approaches to policy making and

Asian Century

Middle Income Trap

Asia

51%

32%

PRC

22%

11%

India

14%

6%

confidence between the major economies will

United States

14%

21%

be vital for effective regional cooperation and

Asia

148

61

PRC

63

21

India

40

12

United States

40

40

World

292

191

maintain a laser-like focus on results adopted by many Asian economies in the past. t


GDP (trillions $ MER)

Third, building much greater mutual trust and

collaboration.

GDP per capita ($ PPP)

t


Fourth, the commitment of Asia’s leadership to modernize governance and institutions on a continuous basis, while enhancing transparency and accountability throughout.

The human dimension

Asia

38,600

20,300

PRC

47,800

23,700

India

41,700

17,800

United States

98,600

98,600

above, as well as the related institutional reforms

World

36,600

25,900

have long gestation periods that extend over many

Source: Centennial Group projections, 2011.

The changes in policies and strategies proposed

decades. Yet, their impact must be seen well before 2050 to allow the region to continue on its path to prosperity.

The intangibles

Actions of Asia’s political, policy and business leaders today—and their successors in the future—

As important as the inter-generational issues highlighted above are for individual countries, four overriding non-tangibles will ultimately determine the

a reality, or remain a tantalizing promise. The difference in the outcomes under the two

region’s ability to resolve them and thereby shape

scenarios and thus the opportunity cost of not real-

Asia’s long-term destiny:

izing the Asian Century scenario is huge, especially in

t


First, the ability of its leaders to persevere during the inevitable ups and downs and to

human terms. Under the Asian Century scenario, almost 3 bil-

maintain a sharp focus on the long-term—

lion additional Asians will be able to enjoy the fruits

despite the relentless pressures of day-to-day

of an affluent society at least one generation earlier

concerns and problems. This is critical to

than under the Middle Income Trap scenario. It will

sustain the current momentum for another forty

be the making of a true Asian Century where over 90

years and to make continuous adjustments

percent of Asians will share in the fruits of the region’s

in strategy and policies to respond to chang-

affluence.

ing circumstances and shifting comparative advantage. 120

will determine whether the Asian Century will become

Asia’s future is fundamentally in its own hands.

Annex 1 Demographic Changes in Asia’s Regions by 2050 By 2050, Asia will constitute about 53 percent of the global population, a little smaller than its 57 percent share in 2010, but with nearly 1 billion more

people to its total, and Viet Nam by over 25 percent with 23 million more. Central Asia will add around 85 million people by 2050. It will be growing from relatively smaller

people than today. Northeast Asia’s share in all of Asia’s population

absolute numbers—but in percentage terms this

will have fallen from nearly 40 percent in 2010 to

subregion, especially Afghanistan and Iran, will be

roughly 30 percent in 2050. What is concealed in this

growing dramatically. It is estimated that Afghanistan’s

general number is the fact that Japan and Republic

population will skyrocket from its current 29 million

of Korea’s populations will continue to fall, and by

to 74 million; Iran will add about 22 million to its total

2050, will have fallen dramatically by 20 percent and

population.

9 percent, respectively. Any population growth in

In 2050, Asia will be heavily influenced by the

Northeast Asia stems predominantly from PRC—but

relative demographic weight of South Asia. Already

in percentage terms PRC’s population will have only

by 2023—roughly a decade from now—South Asia

grown by 4.6 percent in the 40 year period between

(with India) will be more populous than Northeast Asia

now and 2050.

(which includes PRC). By 2050, Pakistan will have

Southeast Asia is expected to grow faster than

added more than twice the amount of people than

the Asia average and to add about 174 million people

PRC to the total Asian tally. The balance of Asia’s

by 2050. In the period 2010 to 2050, Indonesia will

population will have shifted from Northeast Asia to

have grown by nearly 24 percent, adding 55 million

South and Southeast Asia.

Figure A1

Population changes in Asia’s subregions, 2010 versus 2050

Asia Populaon 2010

Asia Populaon 2050

Central Asia 5% Southeast Asia 15%

Central Asia 5% Southeast Asia 16% Northeast Asia 33%

Northeast Asia 39% South Asia 41%

South Asia 46%

Source: United Nations Statistics Division, 2010.

121

A1

Table A1

Population changes in Asia, 2010-2050

population than before. India, on the other hand, will have grown by 400 million people to a total populaChange in Population (millions)

% Change

3958

4888

930

23.5

largest countries in the world will continue to be domi-

127

102

-25

-20.0

nated by Asia. Between now and 2050, there will be

49

44

-4

-9.1

PRC

1354

1417

63

4.6

Indonesia

233

288

56

23.9

Viet Nam

89

112

23

25.4

India

1215

1614

399

32.9

Pakistan

185

335

150

81.4

Afghanistan

29

74

45

155.1

Asia Japan

2010

Population (millions)

ANNEX 1

Projected 2050

tion of over 1.6 billion people in 2050; its share of the

Republic of Korea

total global population will have grown to nearly 20 percent. The demographic dominance of PRC and India notwithstanding, in the next decades the list of the

three additional Asian countries with the distinction of belonging to the ten most populous countries in the world: besides PRC and India, there will be Pakistan (335 million), Indonesia (288 million) and Bangladesh (222 million) in the “top ten”. Asia’s ageing trends

Source: UN Statistics Division, 2010.

The demographic figures for Asia in 2050 impress by the sheer numbers of its growing population: 40 years from now, Asia will have a population of nearly 5 billion. Projections on how many of these people will

The Asian population giants, PRC and India will see very different demographic trends. By 2050,

be officially classified as ‘elderly’ are just as impres-

PRC’s population is estimated to have already

sive: in 2050, nearly 860 million Asians will be 65

peaked around 2032, and be at 1.4 billion, which is

years and older. What is especially striking about this phenomenon

only 63 million more than in 2010. By 2050, PRC will

is the relative speed of the process of ageing in Asia,

thereby represent a smaller share of the total global Table A2

Projected growth of Asia’s elderly population (number of people, age 65 and above, in millions)

2010

2020

2030

2040

2050

% increase 2010-2050

9

12

19

25

36

309

Northeast Asia

149

214

286

377

392

163

South Asia

77

111

161

221

299

290

Southeast Asia

34

49

76

106

132

283

TOTAL

269

385

541

729

859

Central Asia

Source: UN Statistics Division, 2010.

122

and the fact that the ‘greying’ of Asia is occurring at

and Viet Nam, and three, the youngest countries

all levels of the economic spectrum, i.e. even in low-

in Asia that are still growing, much further away in

income countries.

their demographic transitions, such as Pakistan and Very Young Asia.

Asia’s 3-speed ageing world

ANNEX 1

Afghanistan, for instance—referred to as Speed 3 or

A1

By tracing the population figures for some of the In the context of demographics, it is tempting to

major (already large) Asian countries, it becomes

borrow the analogy to the differential-speed eco-

evident that PRC’s population begins to decline

nomic growth framework that is used in the economic

around 2032, Republic of Korea as early as in 2024,

model that underlies the report.

and Thailand will begin shrinking in 2040. Japan’s

The three-speed demographic taxonomy in Asia

demographic descent has already begun; its popula-

occurs around distinct groups: one, the ageing coun-

tion reached its peak in 2005; India’s demographic

tries in Northeast Asia (notably, PRC and Republic of

inflection point occurs only after 2050; the same

Korea; from now on referred to as Speed 1 or Old

applies to Indonesia, Viet Nam, Bangladesh, Pakistan

Asia); two, the countries in Southeast and South

and Afghanistan. Tracing the percentage of the total population that

Asia that are approaching the demographic transition (called Speed 2 or Young Asia). This group covers

is of a working age (defined as 20-64 years of age)

a wide spectrum of countries such as Thailand and

also reveals different and differently timed inflection

Indonesia that are relatively older, and other countries

points: for Speed 1 countries, the old countries of

that are roughly 10 years further behind, such as India

Asia, the working age population has already peaked

Table A3

Asia’s differential-speed demographic inflection years

Inflection years

Total population

Speed 1: Old Asia

Working Age Population Speed 1: Old Asia

Japan

2005

Japan

Republic of Korea

2024

Republic of Korea

2015

PRC

2032

PRC

2020

2039

Indonesia

2030

Speed 2: Young Asia Thailand

1995

Speed 2: Young Asia

Indonesia

Post 2050

Thailand

2040

Viet Nam

Post 2050

India

2040

Bangladesh

Post 2050

Viet Nam

2040

India

Post 2050

Bangladesh

2045

Speed 3: Very Young Asia

Speed 3: Very Young Asia

Pakistan

Post 2050

Pakistan

Post 2050

Afghanistan

Post 2050

Afghanistan

Post 2050

Source: Authors’ calculations based on data from United Nations Statistics Division, 2011.

123

A1

Table A4

Ageing versus economic growth in Asia, 2050

ANNEX 1

Nepal

pc GDP (PPP) 2050

% 65+ 2050

3,400

10.6%

Iran

pc GDP (PPP) 2050

% 65+ 2050

22,800

19.7%

Afghanistan

2,800

3.6%

Cambodia

22,700

10.4%

Bangladesh

14,200

14.9%

Viet Nam

33,800

20.0%

Myanmar

4,900

17.5%

Armenia

35,900

21.5%

Tajikistan

15,900

10.0%

India

41,700

13.7%

Lao PDR

7,800

9.5%

Bhutan

48,600

15.0%

Pakistan

7,900

10.0%

Indonesia

37,400

18.6%

22,900

12.7%

PRC

47,800

23.3%

Philippines Sri Lanka

34,700

21.4%

Azerbaijan

60,300

17.9%

Mongolia

26,900

16.8%

Kazakhstan

64,700

15.6%

Source: Centennial Group International Growth Model, 2011.

and is now declining (as in Japan) or is about to do so

status. The fear that a country might become too old

(as in Republic of Korea). Working age populations in

before it becomes rich enough has two elements: (i)

the Speed 2 countries (“Young Asia”) trail the Speed

with high old age-dependency ratios, investments to

1 countries by about 20-25 years (e.g. Indonesia,

achieve higher factor productivity are difficult to real-

Thailand, India). These inflection points are an impor-

ize, and (ii) meeting the needs of an elderly population

tant indicator of demographic windows of opportunity

will entail costly economic and social institutions that

and potential demographic dividends that countries

are needed to achieve income security, adequate

could exploit to their advantage.

health care, and other needs1.

An important, valid concern is that a rapidly ageing population is antithetical to achieving high-income

1 Ronald Lee, Andrew Mason, and Daniel Cotlear, “Some economic consequences of global ageing,” Washington, DC: World Bank, 2010.

124

Annex 2 Model for Developing Global Growth Scenarios This study estimates GDP as a function of labor force, capital stock, and total factor productivity

‫ܯ‬age,country,t = ݉ age,country × ‫ܯ‬age,country,t−1

(2)

for 183 countries between 2010–2050 under two different growth scenarios that we call the “Asian

where ‫ ܯ‬is the percent of males in age group age

Century” and “Middle Income Trap”. As seen in

who are active in the labor force and ݉ age is a

equation (1), a Cobb-Douglas function with constant

constant that varies for each country and age group.

returns to scale is assumed.

The cross-country, cohort-specific equations to forecast the differentials between male and female

GDP = TFP × L × K1−

(1)

participations rates are the autoregressions: ln(Dage,t) = ݀ age × ln(Dage,t−1)

GDP figures are generated for three different

(3)

measures: (i) real GDP (constant 2010 prices), (ii) GDP PPP (constant 2010 PPP prices), and (iii) GDP at

where D equals the difference between the

expected market exchange rates, which incorporates

percentage of males in age group age in the labor

exchange rate movements and serves as this study’s

force and the percentage of females in age group age

best proxy for nominal GDP.

in the labor force and ݀ age is a constant that varies by

This model first estimates a full time series of yearly real GDP growth for each country for every

age group. Capital stock growth is based on an initial capital

year between 2010 and 2050. These estimates are

stock, calculated by using the Caselli method1, and

applied to the previous values of real GDP, GDP PPP,

yearly investment rates and depreciation. The Caselli

and nominal GDP deflated by US inflation (on which

equation used is:

GDP at market exchange rates is based) to derive the full series. Finally, to derive GDP at market exchange

K0 =

rates, real exchange rate appreciation is calculated

I0 g + 0.06

(4)

and multiplied by nominal GDP (deflated by inflation) to obtain GDP at market exchange rates. Labor force growth stems from population growth

where K0is the initial capital stock, g is the average GDP growth over the subsequent ten years, 0.06 is

and from changes in labor force participation rates,

the depreciation rate, and I0 is a representative yearly

which are calculated separately, by gender, for six

capital investment.

age cohorts (15-19, 20-24, 25-49, 50-59, 60-64,

The model is calibrated by calculating Total Factor

and 65+) to better capture cohort-specific trends.

Productivity (TFP) for an initial year (2011) based on

Male rates are projected directly; female rates are

labor force, capital stock, and historical GDP. For

derived by projecting the difference between male

subsequent years, TFP is projected.

and female rates for each age group. Labor force

For the TFP projections, we differentiate four tiers

participation rates from 1980 through 2020 are from

of countries: (i) rich or developed; (ii) converging; (iii)

the International Labor Organization.

non-converging; and (iv) fragile.

The country-specific and cohort-specific equations to forecast male rates are simple autoregressions:

1 Kharas, Homi, “India’s Promise: An affluent society in one generation,” in India 2039, An Affluent Society in One Generation, Kohli and Sood (eds.) Washington, DC: Sage, 2010

125

A2

All countries begin with a default TFP growth

TFPGrowth = 1.3% + CB − FP

(5)

rate of 1.3 percent per annum derived from past

ANNEX 2

studies2. This parameter is close to the 100-year TFP

where CB is the convergence boost benefiting

growth rate of the United States, and is treated as the

“converging” countries and FP is the productivity

global standard. In our model, this is the fixed rate of

growth penalty suffered by failing or fragile states.

productivity growth for non-converging, non-fragile

The convergence boost is defined as follows:

countries. Research shows that some growth differences

CB = c × 1.26% × ln

(

between developing countries can be successfully

TFPUSA,t−1 TFPi,t−1

)

(6)

modeled by separating them into two groups: converging (Tier 2) and non-converging (Tier 3)

where i is the country, 1.26 percent (rounded) is the

countries.

convergence coefficient (derived from historical data),

A country is deemed to be converging if its per

TFP is the total factor productivity based on real GDP

capita income has rapidly converged over a 20-year

(as opposed to PPP), and c takes a value between 0

period to that of best practice economies; the lower

and 1 and identifies whether a country is treated as a

its productivity relative to the global best practice the

converger (c=1) or as a non-converger or fragile state

more quickly it converges. This convergence reflects

(c=0), or in an intermediate state of transition between

technology transfers from richer innovative countries,

being a converger and non-converger (0 < c < 1).

technology leapfrogging, the diffusion of management

The failed-state penalty FP is defined as

and operational research from more developed F= ܽ × 1.8%

countries, and other ways that a country can shortcut

(7)

productivity-improvement processes by learning from economies that are already at the productivity frontier. In the model, the lower the country’s productivity relative to that of the US, the larger the boost, and the quicker the

catch-up3.

The productivity growth of rich

where ܽ plays a role analogous to that of c in equation (6) above. For fragile (Tier 4) nations,  is set equal to 1, corresponding to a penalty in productivity growth of 1.8 percent, so that their yearly productivity is

(Tier 1) countries is treated the same as that of Tier 2

assumed to fall by 0.5 percent a year. The coefficient

countries. On the other hand, non-converging (Tier 3)

of 1.8 percent and the list of such fragile states is

countries have only 1.3 percent productivity growth

derived by identifying state failures and debilitating

and no boost. The general equation for TFP growth

wars in 53 nations since 1980 (totaling 646 country-

encompassing all countries is

year observations). The projections of GDP growth are concluded by applying the labor growth, capital deepening, and

2 Kharas, Homi, “Latin America: Is average good enough?” in Latin America 2040, Kohli, Loser and Sood, (eds.) Washington, DC: Sage, 2010. 3 TFP is used in the convergence term instead of the per-capita income used by others for three reasons: first, if the equation were to use GDP per capita, over time the TFP of a converging country will not converge to that of the USA but instead to other values. Also, since the convergence equation represents convergence of TFP, we use TFP in order to make the equation consistent with its purpose. Third, using the convergence coefficient from past research in tandem with an income-based convergence term yields large discrepancies with the recent historical data for TFP growth.

126

productivity changes to each country over the period 2010-2050. The measure of GDP at expected market exchange rates adjusts the GDP estimate by expected changes in the real exchange rate. First, an equation is derived to establish a theoretical relationship between a country’s real exchange rate

using a similar analysis of recent historical data6.

the country’s modeled exchange rate converges

The model assumes that in the future: (i) all eleven

towards the value that corresponds to its income in

currently converging economies in Asia will continue

this theoretical equation. Since these relationships

to converge; (ii) eleven Asian (and six non-Asian

are not linear, the countries for which an increase in

economies) will gradually also become convergers;

GDP PPP most appreciates their real exchange rates

and (iii) all failed states will gradually stop failing and

are the countries whose incomes are between a third

graduate to the third group in 2025. The convergence

and two-thirds that of the United States, and not the

of the six non-Asian non-convergers and the fact that

poorest or richest countries.

all failing states eventually stop failing in this scenario

The model also projects the sizes of the lower, middle, and upper classes, again following Kharas

results from the “Shared Prosperity” that benefits the entire world.

(2010), by measuring the number of people in each

The second scenario is the “Middle Income

country with living standards—in PPP terms—within

Trap Scenario”. Here, all currently converging Asian

a certain absolute range. An income distribution

countries with a GDP PPP per capita in 2010 below

for each country is derived from the World Bank

$20,000 are assumed to fall into the Middle Income

International Comparison Program. As a country’s

Trap. They gradually stop converging at varying

total income increases, more people with small

income-dependent points between 2015 and 2020,

shares of the country’s total income will attain higher

and remain non-convergers for the rest of the time-

living standards.4

frame.

The study makes separate projections for the

In both scenarios, the transition of individual

Asian Century and Middle Income Trap scenarios.

countries between converging and non-converging,

The difference between the scenarios is how

or from failed to non-converging is gradual. That is,

countries are classified, either as converging, non-

countries are made to adopt an intermediate state

converging, or failed, and how countries gradually

between failed and not failed, or between converging

move between classifications.

and not-converging, by varying the values of f and c in

For the first scenario (“the Asian Century”), the

A2 ANNEX 2

and its PPP income relative to that of the US. Then,

equations (6) and (7)

starting point is the countries’ status in 2010: 38 countries (7 Asian) are rich, 32 (11 Asian) converging, 111 (29 Asian) non-converging, and 14 (2 Asian) failed.5 For 137 countries, the classification is taken from the “Four-Speed World” classification used by Kharas. The remaining 51 countries were classified 4 The model also projects requirements for ten infrastructure sectors: Airports, Electricity, Fixed Broadband, Landlines, Mobile Telephony, Ports, Rail, Paved Roads, Sanitation, and Water (although not all sectors are covered for each country).They identify needs in both physical capacity and investment costs, which are broken down into new investment and maintenance. The models used for these projections are structural equation models based on instrumental variables, and their methodology and specifications are given in Kohli and Basil (2011), with a brief overview provided in Kohli and Basil (2010). 5 Projections could not be made for 13 of these 196 countries because the required data is not available.

6 However, unlike the Kharas classification, this study does not distinguish between middle income non-convergers and poor non-convergers. We argue that during the next forty years many poor or lower-middle income countries will graduate to middle income status.

127

Asia is in the midst of a truly historic transformation. If it continues to grow on its recent trajectory, it could, by 2050, account for more than half of global GDP, trade and investment, and enjoy widespread affluence. Its per capita income could rise sixfold. It thus holds the promise of making some 4 billion Asians, hitherto commonly associated with poverty and deprivation, affluent by today’s standards. By nearly doubling its share of global GDP (from 27 percent in 2010 to 51 percent by 2050, Asia would regain the dominant global economic position it held some 250 years ago, before the Industrial Revolution. Some have called this possibility the “Asian Century”. While this promising outcome, premised on the major economies sustaining the present growth trajectory, is plausible, it does not imply that the path ahead is just doing more of the same. Indeed, just maintaining the present growth rates will require urgently tackling a broad array of politically difficult issues over a long and sustained period, even though benefits may not be obvious in the near term. Asia’s rise is by no means preordained.